Description

• Asset portfolio consisting of large-scale leisure-integrated residential resorts primarily in Greece and Cyprus.
• Currently trading at an 80% discount to NAV.
• Divestment strategy adopted on December 19, 2016, targeted at disposing all of the company’s assets by December 31, 2021, to unlock shareholder value.
• Investment Manager incentives linked to actual shareholder distributions.
• Investment Manager owns significant share of the company.

Introduction

Dolphin Capital Investors Limited is a real estate investment company focused on early stage, large-scale leisure-integrated residential resorts in south-east Europe, and is managed by Dolphin Capital Partners Limited (the “Investment Manager”), an independent private equity management firm that specializes in real estate investments, primarily in south-east Europe.

The company was admitted to trading on the Alternative Investment Market of the London Stock Exchange on December 8, 2005, as a newly incorporated closed-end investment company. At the time of admission, the directors of the company undertook that shortly before the tenth anniversary of the initial admission the board would convene a shareholders’ meeting at which the future of the company would be determined. The board, following this commitment and working together with the company’s Investment Manager, proposed a New Asset Strategy, which was approved by shareholders at the Extraordinary General Meeting on December 19, 2016. The New Asset Strategy set in motion the orderly sale of all the company’s assets by December 31, 2019, accompanied by changes to the company’s investment policy, distribution policy and the remuneration structure for the Investment Manager.

On May 2, 2019, shareholders approved a two-year extension of the company’s divestment period to December 31, 2021 and reduced the fixed management fees while further aligning variable fees by linking them to actual shareholder distributions. Since the adoption of the initial disposal strategy in 2016, the company has been able to execute six significant asset disposals at an aggregate enterprise value of €344m, reduce the group debt by more than €210m and achieve important permitting and entitlements decisions for its remaining asset portfolio.

As of June 2020, the company’s net asset value was €164m with just €6.6m of group debt left, which is entirely at the project level. At the current market cap of €30.40m, the company is trading at an 80% discount to NAV, reflecting the uncertainty about amount and time of shareholder distribution from the proceeds of the asset disposals. However, with a catalyst in place and incentives aligned, the current valuation provides a significant margin of safety against challenges in the execution of the divestment strategy.

Incentives

Charlie Munger famously said, “Show me the incentive and I will show you the outcome.” Understanding the Investment Manager’s (“IM”) incentive in driving the desired outcome for shareholders is a crucial part of the investment thesis.

The IM get a fixed fee of €3.6m per annum and a variable performance fee equal to a percentage of actual distribution to shareholders. The renumeration was originally changed with the implementation of the divestment strategy in 2016 and has been improved since to further align the IM’s incentives with shareholder interests. The fixed fee has been gradually reduced from €8.5m in 2016 to €3.6m for 2020 and 2021. The Investment Management Agreement (“IMA”) will expire at the earlier of December 31, 2021, or the sale of all the company’s assets; there will be no fixed management fee due thereafter. The variable fee was increased and tied to the actual amount distributed to shareholders. Although, as we see in the table below, the IM’s biggest incentive for a large and timely distribution of proceeds to shareholders is not the variable fee but the IM’s own significant share of the company.

Source: Author’s calculation based on company's financial report

The first three columns of the table show the variable management fee structure; the more money that gets distributed to shareholders, the higher the performance fee for the IM. More significantly, the IM – Dolphin Capital Partners – own 9.73% of Dolphin Capital Investors, of which 75% is attributable to Miltos Kambourides, founder and managing partner of DCP and board member of DCI. In total the IM can make as much as €20m from the performance fee and his share in the distribution, if they manage to distribute around three quarters of current NAV to shareholders. If the IM made no effort to divest the assets until the end of the IMA, they would earn a total of €7.2m in fixed fees compared to a total of €26.86m (total incentive + fixed fee), or 3.7 times that, if they manage to distribute three quarters of current NAV to shareholders.

Lastly, shareholders’ interests are aligned with and represented by a number of funds and individuals, who collectively own the majority of the company and all want the same outcome: large and timely distribution of divestment proceeds to shareholders.

Source: Dolphin Capital Investors Investor Relations

Valuation/Expected Return

Net asset value was GBP 150m or GBX 16.58 per share as of June 30, 2020. Current share price and number of shares, as at Jan 10, 2020, stand at GBX 3.36 and 904.63m for a total market cap of GBP 30.40m, an 80% discount to NAV. Total debt of GBP 6.6m, down from around GBP 232m at year-end 2015, is entirely at the project level, non-recourse to the parent company. (Last year the company created a NAV accretive gain of €9.6m from a discounted prepayment of a €15.7m loan for €6.1m.) The steep discount to NAV reflects the uncertainty around i) amount and ii) time of shareholder distribution. If there was no uncertainty regarding these two factors, one could precisely calculate the expected return of the investment, but if not for the uncertainty, this opportunity wouldn’t exist in the first place, because the share price would already reflect the expected value of the situation. Since I don’t believe in trying to forecast i and ii to arrive at a pseudo precise expected return, I’ve done the inverse instead. I’ve looked at the annual rate of return at different levels of i (expressed as fractions of NAV) and ii (year of distribution), as shown below:

Source: Author’s calculation

Aside from the obvious the underlying assumptions of the calculation are as follows:

• NAV decay of GBP 7.12m per annum due to operating expenses, i.e. investment manager and director renumeration, professional fees, administrative and other expenses and depreciation.
• Distribution adjusted by variable management fee corresponding to amount distributed to shareholders.
• Distribution amount in whole at the end of the corresponding year.
• Distribution discounted at 10% per annum.

If the company manages to complete the divestment strategy until December 31, 2021, you’re looking at an annualized return between 4% and 298%, depending on the fraction of NAV that is realized in the liquidation and distributed to shareholders. More importantly, even if the liquidation is drawn out until the end of 2024, you’re still looking at 7% to 27% per annum, as long as at least 50% of the NAV of that year is distributed to shareholders. That’s including the adverse effects of time value of money (10% discount rate) and decaying NAV (GBP 7.12m per annum) considered in this calculation. The current discount to NAV provides a significant margin of safety against challenges in the execution of the divestment strategy both in terms of amount distributed and time of distribution.

The Assets

The goal of this section is to give you an overview of the main assets of the company. I’m not a real estate expert and I don’t pretend to be able to assess the carrying value of these assets on the company’s books. I’m also not confident in my ability to forecast the time of sale for these assets beyond the company’s indicated timeline implied by the divestment period.

The company’s asset portfolio comprises two categories:

1. Kilada Hills Golf Resort, One&Only Kéa Island and Aristo Developers, the three assets that are predominantly relied upon to facilitate material distributions to shareholders and
2. the remaining asset portfolio, which the company intends to opportunistically monetize as soon as practicable taking into account, permitting and zoning status as well as overall market conditions.

• One&Only at Kéa Island, Greece

One&Only Kéa Island is Dolphin’s third resort in Greece to be constructed on the island of Kéa, the closest Cycladic island to Athens. It is accessible through a 15-minute drive from Athens International Airport to Lavrio Harbour, followed by a 30-minute boat ride. Scheduled to open in summer 2022, the project will consist of 75 standalone hotel guest rooms with private pools, two restaurants, an extensive beach club, spa facilities and boat pier as well as a number of villas. 

On May 27, 2019, Dolphin has entered a joint venture agreement with One&Only to finance the construction of the Kéa Island resort of which Dolphin now retains a 33% stake. Here are some rendered images of the villas from the project’s website.

Source: https://www.oneandonlyresorts.com/kea-island

• Kilada Hills Golf Resort, Greece

Kilada Hills Golf Resort represents the development of the most exclusive golf residential community in Greece, a few minutes’ drive from Amanzoe, to include the first Jack Nicklaus championship golf course in the country, together with over 230 luxury serviced residences.

Kilada is moving closer to commencement as the issuance of the final construction permit for the first phase of the project, including the golf course and infrastructure for the first residential lots, is expected shortly. The issuance of the construction permit will enable the company to start the pre-sale process of the residential lots. Together with the golf course, a luxury club house, with amenities to cater for the entire family, such as restaurants, a gym, spa and swimming pool, will be built and an exclusive beach club will also be available for the lot owners of the golf community

On December 18, 2019, Dolphin signed an agreement with an international investor for a €12 million preferred equity investment into Kilada. Under the terms of the agreement, the investor would be entitled to a priority return of the total investment amount from the net disposal proceeds realized from the project and will retain a 15% shareholding stake in Kilada. The project development is now fully financed.

• Aristo Developers

Aristo Developers is a large private landowner and one of the largest holiday home developers in Cyprus. DCI has a 47.9% stake in Aristo Developers.

On September 29, 2016, DCI had signed an agreement to sell its then 49.75% stake in Aristo Developers to Mr. Theodoros Aristodemou (chairman of Aristo) and his family for a €45 million cash consideration. This represented a 70% discount to the carrying value as at December 31, 2015, reflecting Aristo’s debt restructuring agreed with Bank of Cyprus. The sales agreement has been terminated by the company effective May 3, 2017, due to Mr. Aristodemou’s failure to settle the deferred payments as they became due. The company received €1.8 million from this transaction and has retained a 47.9% stake in Aristo. The carrying value of DCI’s shareholding in Aristo has been reduced by a total of €144 million to account for the debt restructuring and the sales price to Mr. Aristodemou. Since the termination of the transaction Aristo’s sales have increased from €31m in 2015 to €66m in 2019.

The company has recently been taking steps to extract value from its shareholding in Aristo in other ways and has been able to structure a transaction, which enabled it to receive €9 million from the transfer of preferred shares, granting beneficial ownership over certain Aristo owned land plots to Mr. Aristodemou, without diluting the company’s shareholding and voting rights in Aristo. Although the shareholding in Aristo represents significant underlying value in a leading development company with a substantial property portfolio and growing sales, it remains a minority stake in a privately held company and, as such, has proven difficult to monetize, short of the outright sale of the whole stake to Mr. Aristodemou, the most obvious buyer.

DCI’s remaining portfolio includes Scorpio Bay, Lavender Bay and Plaka Bay in Greece, Apollo Heights in Cyprus, Livka Bay in Croatia. Scorpio Bay, Lavender Bay, Plaka Bay and Apollo Heights have not reached permitting maturity yet and remain essentially greenfield projects. The company has been working to achieve planning and permitting advances in all four projects and market them to other developers and/or land investors. Livka Bay is fully permitted and currently being marketed through local and international real estate agents to potential acquirers.

Conclusion

Let me be clear, this is by no means a sure thing. Your expected returns are fully dependent upon the Investment Manager’s ability to execute the divestment strategy and dispose all of the company’s assets at the highest possible valuation and the shortest period of time. There’s a lot of things that can go wrong and cause a prolonged divestment period or less than expected sales prices, the two main risks for shareholders. Fortunately, the prevailing undervaluation of the shares implied by the 80% discount to NAV provides a significant margin of safety against these risks. Even if the finalization of the divestment strategy is drawn out until the end of 2024 and only 50% of the remaining NAV of that year is distributed to shareholders (adjusted for time value of money and decaying NAV due to annual expenses), you can still earn a reasonable return of 7% per annum in a severe downside case. If the company manages to finalize the liquidation by the end of 2021, as is currently intended, the returns can be as high as 298%. The setup is pretty much as good as it can be for this type of situation barring more certainty about timing of asset disposals and sales prices. The risk/reward is clearly skewed to the upside with lots of value, a catalyst and the right incentives to drive the desired outcome for shareholders.

Catalyst

Execution of divestment strategy