Finding value in Gotland, the Baltics and Russia
Gotlandsbolaget and Eastnine
I have been thinking for a long time that I should do a renewed write-up of my longest standing holding, the ferry operator Gotlandsbolaget, which I started buying back in 2013. Because I traveled a bit shortly before the re-listing last week, it didn’t happen in a timely manner before the first trading day. The unexpectedly large run-up in the stock sadly zapped my energy to do a more thorough write-up which would make the company understandable to an international audience.
But it is an odd and interesting company for all kinds of reasons: the outstanding historical performance under grand old man Eric D. Nilsson (95 years old, honorary chairman and now the oldest board member of a publicly listed company in Sweden); the extremely moaty business resulting from essentially uncontested government procurement of the ferry line services; the consistently profitable ship trading; the de-listing and extremely large historic buybacks followed by a decade plus of cash-hoarding. Followed by whatever will happen now that the company has re-listed and said that they will re-evaluate their — extremely stingy — dividend policy.
Thanks for reading alwaysinvert investing! Subscribe for free to receive new posts and support my work.
Additionally, the island of Gotland has increased even more in geopolitical importance since Russia’s invasion of Ukraine and Sweden’s and Finland’s resulting applications to join NATO. You can find a good explanation of its strategical importance here. Possibly, I will find reason to return to the company if they decide to make some structural changes.
I will instead highlight another company with values highly dependent on the dynamics between Sweden, Russia and NATO. This is yet another RE company listed on Nasdaq Stockholm called Eastnine. Eastnine started in 2007 as East Capital Explorer, an investment company in Eastern Europe and Russia. It was reoriented into a real estate company in 2017 and has been busy selling off non-core assets since. The It owns real estate in Vilnius (67%) and Riga (13%) and has also recently entered Poland via a purchas in Poznan (20%) recently, where they are looking to grow further with acquisitions. Instead of typing up long-winded explanations of all the intricacies of the company, I will link a very recent video presentation and proceed under the assumption that the reader has watched it.
As mentioned, the company has been in the process of clearing off all its non-core assets. The last piece of that puzzle is a stock holding in the Russian company Modern Fashion Group (MFG). It was to be listed on the Moscow stock exchange during the spring, making it a more liquid position. Naturally, this plan was completely upended by the invasion of Ukraine and the following implosion of the Russian stock market. Ever since, the market has been skeptical of any remaining value in this asset.
On October 19th, a deal was struck to sell the shares in MFG for the equivalent of €193 million to the Russian conglomerate Sistema. This was €53 million higher than its value on the books as of Q2. The deal has not yet been finalized, although management still as of the above presentation (Dec 6th) holds to a timeline of before end of 2022. Market pricing seems to imply extreme doubt that this will happen, but let me come back to how I think about that in more detail later on.
First, let’s look at the relative pricing of Eastnine and compare their positioning in its real estate business versus its Swedish peers.
As I’m sure people are aware, real estate across the globe is having a bad time, and Swedish RE even more so, at least in parts of the market. Some of the large companies have big financing worries, as they have weighted their financing heavily towards the bond market, which is now for all intents and purposes closed. So, refinancing is a proper headache for companies such as Balder, Castellum, SBB and Corem, among others. Additionally, low yields and sometimes low yields in conjunction with low ability to raise rent along with inflation or heavy investment in developments (as in the Swedish residential segment) is putting stated book values into question.
Eastnine scores well pretty much across all the metrics that the market likes currently. It has an extremely modern portfolio of prime real estate with yields on the books way higher than those found in Sweden. It only has one outstanding bond (matures 2024) and the rest is bank financing. It now has very low vacancy. However, it does have majority fixed rent increases. Hence, they do not get the benefit of contractual full CPI adjustment at current inflation levels, like some of its Swedish peers. However, its assets and large Scandinavian tenants (Danske Bank, Telia, etc) should put them at a relative advantage in terms of raising rent levels over longer periods of time. Eastnine also isn’t overly sensitive to rising costs, as its contracts are triple-net, meaning the surplus ratio is extremely high for an office owner, and the tenant pays for electricity directly. Additionally, the company reports heightened demand in Vilnius and Poland due to Russia’s invasion, as companies look to relocate from Ukraine and Belarus.
There are no perfect peers for Eastnine, as the combination of prime office and high yields on the books doesn’t exist in the Nordics. Entra (not present in the table above because it’s Norwegian), which might be the best peer in terms of category of assets, has a high-ish LTV and still low yields its books. Fabege is also somewhat similar in terms of assets, but they are historically a large developer and while they have an optically low LTV, they also have extremely low yields on their books and is having a bit of a scare around their rating currently. Presumably, Fabege has to sell off assets to institutional buyers in order to defend their stated book value going forward. The Stockholm market is liquid and their holdings are considered cream of the crop generally, so it is certainly possible, but it’s quite a different situation than that of Eastnine.
If we look to immediately after MFG has — presumably — closed, Hufvudstaden is not an awful peer, as it would be similar in its low leverage measured in LTV. Post-closing, Eastnine would have slightly shy of 20% LTV. This would be almost the same as Hufvudstaden’s, with the difference that Hufvudstaden’s yields are 3.5% while Eastnine’s are 5.6%. Now, some of that gap may be entirely warranted by asset type and country risk, but it does make a major difference in interest rate sensitivity to the asset base. And that is one of the major themes in the market currently.
Another peer to look at is Nyfosa, which is a good example of a cash-flow centric commercial real estate company. Its asset mix is considerably more eclectic than Eastnine’s and it runs a pretty high LTV but with a good ICR, as the yields on the books of 5.8% is on the higher side. With a low weighting in capital market financing, Nyfosa’s financials (if not its asset types) are kind of what Eastnine’s might look like in the future, when MFG is gone and the company has acquired more assets to cover its central administration costs better. Eastnine’s yields will likely rise from more Polish assets entering the mix and the surplus ratio will remain extremely high.
As seen in the table above, both Hufvudstaden and Nyfosa trade significantly higher against their NAV than Eastnine. Let’s say that Eastnine post-MFG deserves a 25% discount with an added 10% discount for country risk. That would put its target price at 160.65 SEK, implying an almost 50% upside from here. This would put Eastnine essentially in the middle of the pack valuation-wise, which I think of as very conservative on a relative basis since it would be essentially the safest one of them all financially.
Of course, your mileage may vary with regards to country risk. I’m not under any illusion that the markets will suddenly price the Baltics and Poland at the same risk premium as the Nordics. However, from a purely geopolitical perspective (corruption and internal political stability are other issues), I have a hard time understanding why. If anything, the risk to the Baltics should have decreased from Putin’s Ukraine fiasco. But rather the other way around, the risk has increased in salience in peoples’ minds. If it’s more specifically a question of nuclear risk, then the US should be quaking in its boots just as much if not more than Europe. And Stockholm certainly shouldn’t feel safer than Vilnius.
Additionally, it is arguable that Eastnine as a company will be a better proposition than both Nyfosa and Hufvudstaden. Hufvudstaden is extremely unlikely to grow much, because it has never done so, even in past years when it could have found some objects in its niche and bought them with a decent yield gap. Nyfosa will be limited to, at most, growth from its internal cash flows and those will of course shrink with higher interest rates. Yields also haven’t yet risen much to account for higher rates in the Nordics. Perhaps they can cancel the dividend to find more room for growth, but then that shouldn’t be a positive for the stock.
Eastnine — on the other hand — will be very liquid and with ample opportunity to find high-yielding objects in its target markets and likely cheaper financing in Euro (they will also fund future Polish purchases with Euro-denominated loans). Should MFG close, I would be extremely surprised not to see Eastnine grow a lot more organically than Nyfosa and Hufvudstaden over the next two-three years.
Turning to trying to handicap the MFG situation. First of all, MFG the company has increased in value a lot this year. They are growing like weeds and reaping the rewards of its Western competitors leaving Russia. The question is if MFG has grown in value to a Western, and even more specifically Swedish, owner. This remains to be seen. But the price is probably not very high even if it was a big increase from Eastnine’s valuation.
We do however know that there were several interested parties and some kind of auction procedure. My model for regulatory approval in Russia is essentially that this is never an objective standard and it depends essentially on what the acquirer’s power over the seller is and what its connections to the Kremlin are. If there were several proper bidders for the shares and they are all politically connected, that means that the buyer can’t do funny business with regulatory approval in order to haggle on price after the contract has already been signed. Can I know any of this positively? Obviously not, but it’s a guess from the known facts.
Markets may have had a hiccup when Bonava were informed by the buyer that the sale of its RE business in St Petersburg was blocked by the regulatory authorities. This is the only recent asset sale that I have found which was blocked, but I’m sure there are others. Not much is known about the situation, but I think it’s conceivable that Bonava just had a really bad hand to play. A construction and property management business cannot just move locations . The assets are where they are. And consequently, any buyer of those assets in Russia potentially has the seller by the balls. You have seen similar dynamics play out with auto plants and other heavy industries. On the other hand, a part ownership in a public company, of which there are several known willing buyers, does seem on its face more favorable. The purely financial interests of the Russian state and its allied oligarchs, is essentially to approve all asset sales by Western actors, as long as they are the beneficiaries of the rushed exits, of course. Sometimes however, political considerations will override the financial incentives.
Eastnine’s management has been consistently careful in their guidance with regards to MFG over the years, continually not made big promises and, in hindsight, been on the low side in estimating its value. As of Dec 6th, in the video above, they still held to a close by the end of the year, without any major hedging language. Of course, they are not Russian insiders, and may make misjudgments just like the rest of us. But they have not gone out on a limb before and I think have by and large earned the benefit of the doubt. That doesn’t mean the deal is 100% in the clear — far from it — but it means that it has a very good chance in my mind.
What if the deal breaks? I still don’t think the holding would be entirely worthless. Maybe it breaks, but can be done in the future when Russia doesn’t feel the need to put the screws on Sweden due to the NATO process, meaning it would “only” be a delay. Maybe it could get done at a lower price. Maybe Eastnine can keep it, and after some time get more of their dividends out of Russia. Worst case of course, it breaks and some Russian gangsters find a way to just take the ownership. Or the Russian state expropriates it in retaliation against Sweden and NATO. In my mind a break would, all in all, maybe imply a ~50-75% haircut to the holding’s value. Eastnine’s stock would be down, but I’m not sure it should go down all the way to the troughs before the deal was announced. Perhaps -20%. Markets have gone up a bit since. Also, seeing as nobody thought MFG was worth as much as its ultimate sale price, if it does retain some option value even after a break, this should be reflected in a higher price after break than before deal announcement.
We can also reality check this against the bottom name in the table, Corem, of which readers of this Substack should be familiar. Corem has an LTV of about 50% with an added layer of preferred an D-shares on top. It also has a majority owner who is now in deep financial distress. It’s down to the hilt in developments, chief among them NYC projects which are still mostly empty. It has some truly on the wane office assets in Kista, north of Stockholm. And it suffered negative net leasing in the last quarter. Oh also, it had a failed bond auction recently and has a hybrid refinancing coming up in the summer (but to be fair, they did sign an LOI for a large asset sale after the failed bond auction, so it’s not pitch black). If Eastnine traded at a 75% discount like Corem, that would imply about -45% from here. Now, I don’t want to kick someone who is down, but Eastnine shouldn’t trade anywhere near that level just because of a deal break. The company lacks all of the issues that makes Corem’s situation so especially precarious.
Essentially, a break would not cripple Eastnine’s core operations or ability to fund itself, but would of course be a severe blow to the shareholder values, although far from catastrophic.
If it was not clear before, my calculation of 50% upside if the deal closes is not a prediction of the price action. Rather, it’s a way to try and gauge the fundamental value on a relative basis.
I do however think the immediate dynamic is also somewhat asymmetric to the upside. The stock should go up more in the positive scenario than it will fall in the negative. There has been some large selling since the deal was announced, so I don’t think there is unwarranted speculation embedded in the price. Although, one could always get paraonoid and question what the seller knows that the buyer doesn’t. The largest institutional owner, Lazard, went below 5% in September, though, and it doesn’t seem wholly unreasonable to attribute continued selling pressure to them for the time being. If they are behind the selling, they would probably be the very definition of unthinking institutional money. No other larger sales are evident as of late, and Swedish ownership is usually up to date on a monthly basis via Holdings. When the company is finally transformed into a pure play, it will likely be able to attract some domestic institutional capital — at least when the outflows from the sector stop —, which seems completely absent as of right now. This should also help a rerating, although probably over a longer timeframe.
Alright, so I think it’s relatively likely that the stock will rise more on a close than it falls on a break. But what do I think of the odds? 50/50? Almost certainly much better. 75/25? Better still, is my guess. 90/10? Unsure, but my guess is somewhere in the vicinity. Overly bold? Perhaps. You, the reader, can of course input your own assumptions.
With the risk of looking like a complete clown in a short while, and the history of my recent RE picks in my mind, I will venture to say that this is a highly enticing situation.
Thanks for reading alwaysinvert investing! Subscribe for free to receive new posts and support my work.