Description

Please find the full PDF version of the investment pitch at the following link: 

https://www.dropbox.com/s/x1nty3wraeop0i3/EMITF_Long_Pitch_vF.pdf

----------

Recommendation: Long Elbit Imaging Ltd. Common Stock (NASDAQ: EMITF)

Note: Elbit Imaging Ltd. has 553.1 million shares outstanding at a current price of $0.22, implying a current market capitalization of $121.7 million. The common stock is listed on both the NASDAQ the Tel Aviv Stock Exchange (TASE) and trades under the symbols EMITF and EMIT, respectively. Elbit Imaging Ltd. is a holding company incorporated in Israel that has 5 subsidiaries: Plaza Centers N.V. (56.9% equity ownership, trades under the symbol PLAZ on the London Stock Exchange and PLZ on the Warsaw Stock Exchange), Elscint Holdings & Investment N.V. (100% equity ownership), Elbit Medical Technologies Ltd. (84% equity ownership, trades under the symbol EMTC on the TASE), Elbit Plaza India Real Estate Holdings Limited (47.5% equity ownership), Elbit Fashion Ltd. (100% equity ownership). Also, please note the following currency abbreviations: Israeli New Shekel (NIS), Euro (EUR), United States Dollar (USD). We use the following exchange rates when converting across currencies: USD/NIS 3.48, EUR/NIS 4.81, GBP/EUR 1.21, EUR/USD 1.38.

Introduction

We believe that EMITF is an attractive post-reorg equity with a substantial margin of safety and strong, definable catalysts in the near-term. If the company were to trade at 1x our base case estimate of net asset value $197 million, the equity would realize an upside of 62%, which we think can be reached in the next 2-3 years as the market re-rates the company’s book.

Elbit Imaging is an Israel-based holding company with a complex corporate structure, including full and partial ownership of shopping centers, hotels, residential properties, office space, medical technology companies, a retail company and technology startups. The holding company, Elbit Imaging, recently completed a financial restructuring, leaving former creditors with substantive equity (~95%) in the reorganized company. We believe that the significantly increased trading volume following the restructuring can, at least partially, be explained by former creditors (many of which were Israeli financial institutions) engaging in non-economic selling of its new equity. As we will discuss in more depth later, we believe the market has drastically misunderstood the Elbit Imaging restructuring agreement. Additionally, one of Elbit Imaging’s subsidiaries, Plaza Centers N.V., is currently undergoing a debt restructuring, which has led to a depressed share price (both for PLAZ and EMITF). To add to the complexity of Elbit Imaging, between the holding company and its subsidiaries, there are securities trading on four different exchanges (NASDAQ, Tel Aviv, Warsaw and London).

Not only is it complex, the company is overlooked by investors, as indicated by its limited sell-side coverage. The stock trades at ~22 cents on the NASDAQ, leaving the company off the radar of many larger institutional funds. Elbit Imaging has an unrelated mix of subsidiary assets, ranging from real-estate holdings in Eastern Europe to medical technology companies, making the company unloved by investors. Furthermore, the company has had delayed financial reporting, has held no recent earnings calls and has published key operating metrics exclusively in filings in foreign language, including Hebrew and Romanian.

Catalysts

There are strong, definable catalysts that give us comfort in the market price converging to the intrinsic value of the business. The first is the removal of the NASDAQ delisting threat once the company pursues actions to raise its share price above the minimum $1.00/share required by the exchange. NASDAQ has given the company until September 2014 to resolve this issue and the company has indicated it will comply, using a reverse stock split if necessary. Second, the company’s subsidiary Plaza Centers is expected to conclude its restructuring process in the coming months under Dutch court supervision. Third, deleveraging, asset realization and progress with current real estate projects at Plaza Centers should assist the market in the re-rating of Plaza Centers’ book value. Finally, Elbit Medical Holdings has received a buyout offer of “several hundred million dollars” for Gamida-Cell (28.9% owned by Elbit Medical), according to the 3/18/2014 press release from the company. Reports by Haaretz and Globes, two of Israel’s most prominent newspapers, indicate that Novartis has offered a package of up to $600 million for Gamida-Cell, which engages in stem-cell treatment development.

Company Description

Elbit Imaging is an Israel-based holding company established in 1996. It was originally founded as a spinoff from Elron Electronic Industries and Elbit Systems Ltd. to develop and manufacture medical imaging technologies, but was ultimately sold to Mordechay Zisser (former CEO) who turned Elbit Imaging into a diversified holding company.

The company now operates in the following fields of business:

(1)     Commercial and entertainment centers through its Plaza Centers NV

(2)     Residential projects through Elbit Plaza India Real Estate Holdings Limited

(3)     Hotels through Elscint Holdings & Investment NV

(4)     Medical industries through Elbit Medical Ltd.

(5)     Other industries

Plaza Centers NV is a 56.9% subsidiary of Elbit Imaging that trades on the London Stock Exchange under the ticker (LSE: PLAZ) and on the Warsaw Stock Exchange under the ticker (WSE: PLZ). Plaza Centers is engaged in the initiation, construction, operation, management and sale of real estate property projects, primarily in the commercial sector in Central & Eastern Europe (“CEE”) and India. Plaza Centers has been operational in CEE since 1996 and extended its area of operations to India in 2006. To date, the company has established 34 commercial centers totaling over 1.2mm sqft and has successfully sold 27 operational assets generating $1.7 billion.

Plaza Centers currently owns a portfolio of 7 operating assets and 20 development assets. Its six operating assets in Europe are shopping and entertainment centers totaling 161,000 square meters, which have high occupancy rates (76-100%). Plaza Centers’ seventh operating asset based in India, Koregaon Park, is under a sale agreement to provide 16 million EUR of proceeds (net of debt). Plaza Centers also owns 18 assets in the development stage in Europe and 2 assets in the development stage in India, through a JV with its parent Elbit Imaging (Elbit Plaza India). Many of these properties were purchased pre-financial crisis and have been delayed in the permitting and development phase, but post-restructuring the company plans to complete development of a few projects per year and realize value through asset sales. A project to note is Casa Radio, a 555,000 square meter real estate project being developed in a partnership with the Romanian government in Bucharest, Romania. Casa Radio is expected to consist of a 5-star hotel complex, shopping mall and office buildings. In its JV with Elbit Imaging, Plaza Centers owns a 47.5% stake in Elbit Plaza India, which plans to develop two mega mixed-use projects in the cities of Bangalore and Chennai. The Chennai and Bangalore projects are both residential with ~700 and ~1,000 units, respectively.

Elscint, Elbit Imaging’s hotel division, has an 18 year track record in building and operating hotels in Western, Central and Eastern Europe. Elscint owns and manages three luxury Radisson-brand hotels, which operate under a management agreement with Rezidor Hotel Group.

Radisson Blu Astrid Hotel – Antwerp, Belgium

• 100% ownership
• 247 rooms, 19 apartments

• 100% ownership
• 59 rooms

• 77% ownership
• 424 rooms, 294 apartments

These hotels accommodate 730 rooms and 313 luxury apartments which an average occupancy of ~75%. The Radisson Blu Hotel in Bucharest houses the largest resort casino in Romania. Elscint is also developing a hotel asset in northeast Israel. In 2012, Elbit Imaging sold its 50% interest in a portfolio of hotels to PPHE Hotel Group Ltd. (“Park Plaza”). As consideration for the sale, Elbit Imaging received payments in four components:  (1) 1.7 million shares of Park Plaza trading at EUR 3.6 per share, (2) European options on 1 million shares of Park Plaza with a strike price of GBP 5 per share, maturing at the end of December 2015, (3) European options on 0.7 million shares with a strike price of EUR 5 per share, maturing at the end of December, (4) Loan of EUR 9.4 million at 8% annual interest maturing in December 2013.

Elbit Medical Ltd. is an 84% subsidiary of Elbit Imaging that operates through two subsidiaries: InSightec Ltd. and Gamida-Cell Ltd. InSightec is a 42.8% subsidiary of EMTC, with GE Healthcare as a substantial co-owner. InSightec is engaged in the development, production and marketing of magnetic resonance imaging guided focused (MRgFUS) ultrasound equipment. Its main product is ExAblate O.R., a medical device for non-invasive treatment of conditions such as uterine fibroids, breast cancer, and pain palliation. ExAblate OR received FDA approval for use in treating uterine fibroids in 2005, and since has received FDA approval as well as European CE Mark (Europe’s FDA equivalent) for other uses. ExAblate Neuro, another InSightec product in the development stage, is a medical device used for non-invasive surgical treatment of brain disorders. ExAblate Neuro received European CE Mark in December 2012 and is expected to receive FDA approval in 2015. The potential addressable market for these products is considered to be $13 billion.

Gamida-Cell, a 28.9% subsidiary of EMTC, is co-owned by Clal Biotechnology Industries and Teva Pharmaceuticals. Gamida-Cell is engaged in the development of stem cell technologies with broad based therapeutic potential, particularly in the fields of oncology and inflammatory disease treatment. Its stem cell products are in advanced stages of clinical trials. Most notably, StemEx demonstrated favorable results in a recently completed phase II/III multi-center, multi-national clinical trial that targeted hematological malignancies. It is also developing another product, NiCord, which is intended for patients with malignant and non-malignant hematological and auto-immune diseases.

Elbit Plaza India (“EPI”), a 47.5% subsidiary of Elbit Imaging and 47.5% subsidiary of Plaza Centers, is a JV between Elbit Imaging and Plaza Centers established in order to carry out real-estate development projects in India. EPI began its operations in India in 2006 and is currently developing projects in Bangalore and Chennai through special purpose vehicles with local developers. EPI has completed and reached a sale agreement on one of its commercial development projects, the Koregaon Park Plaza in Pune.

Elbit Imaging has a wholly-owned subsidiary Elbit Fashion that is an exclusive Israeli distributor and retailer of the internationally renowned retail brand name MANGO. The exclusive distribution rights were granted by Punto Fa for a ten-year period ending in 2015. Under the agreement with Punto Fa, Elbit Fashion has guarantees of annual minimum purchases and receives marketing, public relations and store-support services. Elbit Fashion operates 28 stores in Israel.

Elbit Imaging is a 55% owner of Varcode Ltd. a startup active in the field of monitoring processes in the supply chain. Elbit is also a 18% owner of Olive Software, a startup engaged in development and marketing of products that enable a link between newspaper printing and e-publishing.  Olive Software is partially-owned by venture capital firms Sequoia Capital, Pitango Venture Capital and Bluecrest Capital Finance.

Recent Financial Distress

In early 2013, Elbit Imaging began facing cash flow problems. Because of its international real-estate exposure, particularly in European economies struggling with deflationary pressures, it was unable to sell its properties at what the company considered fair, economic prices. Further, the company experienced setbacks on its real-estate projects, caused by permitting delays and tighter credit from lenders for project financing. In January 2013, the company was expecting a NIS 100 million dividend distribution from one of its subsidiaries, Plaza Centers, but the dividend was blocked by the subsidiary’s bondholders. All of this led to a lowering of the Elbit Imaging’s bond ratings. At this point, the company had a fairly significant debt burden (NIS 2.6 billion of debt vs. NIS 154 million of market capitalization in early February 2013), which made it difficult for Elbit Imaging to obtain alternative sources of financing.

The combined effect of market conditions and credit constraints created liquidity issues for the company. In February 2013, Elbit Imaging was to repay NIS 82 million in interest and principal repayment to its Series A and Series B bondholders, but instead announced it would only be able to pay the interest portion of that amount. Later in February, the company decided not to make any payments to those bondholders, putting the company in default. Upon realizing the need for the company to reduce its debt burden to proceed as a going-concern, management began negotiations with its bondholders. These negotiations led to a restructuring agreement, which will be outlined in the following section.

Restructuring Agreement and the Market’s (Over)Reaction

The Elbit Imaging restructuring negotiation with the unsecured creditors, initiated in March 2013, proceeded as follows:

1. March 2013: Management proposed NIS 2.3 billion in net unsecured debt cancellation in exchange for 86% of the fully-diluted equity
2. June 2013: The unsecured creditors, led by York Capital Management (~20% of total unsecured bonds) and Davidson Kempner Capital Management (~15% of total unsecured bonds), countered by proposing NIS 1.2 billion in net unsecured debt cancellation in exchange for 95% of the fully-diluted equity
3. June 2013: Management responded by proposing NIS 2.1 billion in net unsecured debt cancellation in exchange for 90% of the fully-diluted equity
4. February 2014: Management announced an agreement which resulted in NIS 1.9 billion in net unsecured debt cancellation in exchange for ~92% of the fully-diluted equity

On February 18^th 2014, Elbit Imaging announced that it had reached a debt restructuring agreement.  Unsecured creditors cancelled NIS 2.6 billion of unsecured debt in exchange for (i) 509,716,459 ordinary shares, (ii) Series H Notes due May 31, 2018 with principal amount NIS 448 million and (iii) Series I Notes due November 30, 2019 with principal amount NIS 218 million.  In addition, Elbit Imaging amended and extended its NIS 168 million secured loan from Bank Hapoalim to have a new maturity of February 20, 2017.  To compensate Bank Hapoalim for this adjustment, the loan’s interest rate increased by 1.3% and this incremental amount will accrue and be payable upon maturity.  Furthermore, Bank Hapoalim received 16,594,036 ordinary shares.  It is worth noting that in Elbit Imaging’s March 31, 2014 6-K filing that “the company does not expect any material tax liability as a result of the profit from the debt restructuring as it will be offset against carried forward losses and impaired investments in subsidiaries”.

Following the announcement of the restructuring agreement with the unsecured creditors, the stock price plummeted 79% from $0.77 per share on February 14^th to $0.16 per share on February 21^st (a $0.59 per share decrease).  We believe this price behavior was irrational; throughout the process, there were thorough disclosures and management presentations updating the public on the status of the negotiations, making it reasonably easy to follow.  Given this level of public disclosure, it is quite surprising how dramatically the market moved upon the announcement.  To illustrate the logical inconsistency of this movement in reaction to the settlement with the unsecured creditors, we will review the proceedings of the unsecured debt restructuring negotiation and run through some illustrative calculations.

In accordance with the agreement announced February 18^th 2014, the shareholders of Elbit Imaging previous to the restructuring agreement (hereafter “Old Shareholders”) received a $550 million (NIS 1.9 billion) net unsecured debt cancellation.  In exchange, they granted the unsecured creditors an equity stake of 509,713,459 ordinary shares, or ~92% of the fully-diluted equity (553,134,519 total shares outstanding).  The share price falling $0.59 per share implies that the market believed that $326 million of equity value was destroyed through this agreement (553,134,519 shares each losing $0.59 in value). 

If the market previously priced in the June 2013 management proposal, shareholders received $58 million (NIS 200 million) less in debt cancellation and 2% more equity dilution than anticipated, which at $0.16 per share (February 21^st price) equates to $1.8 million.  Overall, the Old Shareholders received about $60 million less than would have been anticipated based upon the June 2013 management proposal. Therefore, the stock dropped over $260 million more than these assumptions would imply (-$326 million versus -$60 million).

Next, let’s consider an arguably more reasonable assumption: that the market priced in the midpoint of the unsecured creditor proposal and the June 2013 management proposal.  The midpoint would be the unsecured creditors receiving 92.5% of the fully-diluted equity in exchange for NIS 1.65 billion in net unsecured debt cancellation.  Under these assumptions, the eventual equity dilution would be slightly better than anticipated, while the Old Shareholders would have received $72 million (NIS 250 million) more in debt cancellation than anticipated.  Overall, the Old Shareholders received about $73 million more than would have been anticipated from the midpoint estimate. Therefore, the stock dropped about $400 million more than these assumptions would imply (-$326 million versus +$73million).

One additional point is that on February 20^th, 2014, a few days after the announcement of the restructuring agreement between Elbit Imaging and the unsecured creditors, Bank Hapoalim and Elbit Imaging announced an “amend and extend” agreement in relation to the NIS 168 million loan.  In the June 2013 management proposal, management discussed providing Bank Hapoalim with NIS 212 million in claims on the firm which is slightly more than the NIS 198 million which was the outcome of the agreement (NIS 168 million in reinstated principal, an additional NIS 16 million in principal from the accrued interest and NIS 9 million in equity at February 21^st share price). This divergence is not substantial, but is slightly beneficial to Old Shareholders.

While this analysis in isolation clearly does not show that the equity is undervalued, it does demonstrate the market’s lack of understanding of the restructuring agreement and helps potential investors understand why this price dislocation exists.

Hedge Fund Involvement

Well-established investment funds, York and Davidson Kempner, were actively involved in the restructuring process, ultimately supporting a plan of reorganization that gave the unsecured bonds ~92% of the reorganized equity, indicating their confidence in the business. As of the F-1 filing on March 12, 2014, York and Davidson Kempner are eligible “selling shareholders”. However, they have not filed a 13-G since the F-1, indicating that as of March 31, 2014, neither fund could have sold more than 5% of the total shares outstanding. Moving forward, we are comforted by York’s (19.7% equity owner) and Davidson Kempner’s (14.3% equity owner) influence within the company, as indicated by their recent appointment of 7 new board members (out of 10 total). In January 2014, Davidson Kempner added to its Plaza Center exposure by purchasing ~5% of the Plaza Centers’ equity. Interestingly, a Globes article wrote that in January 2013 Davidson Kempner and York bought 15% of Elbit Imaging’s bonds (NIS 2,324 face value) at an investment of NIS 150-200mm. This implies that they purchased the unsecured notes at .41-.50 cents on the dollar. Assuming a 41 cent cost basis, in order for Davidson Kempner and York to breakeven on its investment, the stock would have to appreciate 17% from current levels. 

Positive View on Newly Elected Board of Directors and Firing of C.E.O.

On February 27, 2014, shareholders of Elbit Imaging elected seven members to the Company’s Board of Directors in order to replace existing directors. The list of newly elected directors is below:

• Alon Bachar – CFO of Bronfman Fisher’s holding company
• Eliezer Avraham Brender – Founder of Exigent Capital Management, a $300mm hedge fund
• Ron Hadassi – Chairman of the Board of Directors; Senior Manager of the Bronfman Fisher Group
• Shlomo Kelsi – Managing Director and General Manager of Ampal-American Israel Corporation
• Yoav Kfir – Founder and Managing Director of VAR Group
• Boaz Lifschitz – Co-founder and general partner of Peregrine Ventures
• Nadav Livnni – Managing Director of the Hillview Group

Additionally, on March 31, 2014, Elbit Imaging announced that Mordechai Zisser would no longer be serving as CEO and Executive President. We are bullish on the positive effects this new Board of Directors and a new CEO could have. We think that adding experienced professionals to the Board, including real estate executives, a hedge fund manager, a turnaround specialist, a venture investor, and a merchant banker will improve corporate governance and capital allocation decisions in this business. Further, we take comfort knowing that York and Davidson Kempner effectively have veto power through their control of the board.

Plaza Centers Real Estate Exposure

We would like to preface this discussion by stating that we do not have a strong opinion on the future of commercial real estate markets in Central and Eastern Europe. The chart below shows comparable real estate companies with holdings in Europe.

Russia and Ukraine exposures for the comps are broken out as political uncertainty in these countries may adversely impact the companies’ valuations. The average multiple of book asset value for these companies is 0.88x, while the Plaza Centers NV multiple of book asset value is 0.76x. Therefore, regardless of your outlook on CEE real estate, Plaza Centers trades at a material 13.5% discount to peers on an unlevered book basis. Furthermore, it is worth noting that unlike some of these comparable companies, PLAZ has no exposure to Ukraine or Russia. 

As seen in the chart above, Plaza Center’s largest asset exposures are to Romania (38.5%) and Poland (32.4%). Many commentators believe that CEE commercial real estate, particularly Polish real estate, may be at a cyclical trough. The CEE real estate index currently trades at a 84.9% discount to its peak in 2006 before the global financial crisis. JLL reported that in 2013 Poland had its highest level of retail real estate transaction volume since 2006, indicating a rebound in market conditions. Additionally, CBRE reported an over 250% year-over-year increase in Romanian commercial real estate transaction volume in Q4 2013. Again, we do not have a strong view on these markets and appreciate any macro insights the community may have.

Plaza Centers Situation Overview and Restructuring

In 2007-2011 Plaza Centers raised 370mm EUR via an issuance of two bond series (Series A and Series B Debentures) on the Tel Aviv Stock Exchange in addition to 14mm EUR via a bond issuance in Warsaw (Polish Bonds). A summary of Plaza Centers’ debt is shown below.

As of November 2013, the company had a cash balance of EUR 23mm. This balance was not sufficient to meet an obligation to bondholders of EUR 32mm EUR for the end of 2013, and EUR 67mm for the first half of 2014. In November 2013, the company announced that it would freeze all payments to creditors and enter into debt restructuring negotiations. The most recent restructuring proposal has several key terms listed below.

1. Consummation of plan contingent on 20mm EUR equity rights offering
2. Issuance of 13.5% of the company’s shares pro-rata to unsecured noteholders (Series A, Series B and Polish Bonds)
3. All unsecured debt principal payments due during the years 2013-2015 shall be deferred three years. If within 2 years >50% of the debt is repaid, then the remaining principal balance will be deferred an additional year beyond the three year deferral
4. Interest payments missed during suspension period will be added to principal balance
5. Annual interest rate on all unsecured debts will be increased by 1.5%
6. Following consummation, 10.5mm EUR will be paid to Unsecured Debt for 2014 interest payments
7. The company must use 75% of net proceeds received from asset sales to repay unsecured debt

This proposal has been submitted to the Netherlands court and is scheduled to be voted on by creditors on June 26, 2014. The most recent company report indicates that the creditors support this plan but are not bound by it. We believe that this reorganization plan will be completed within the next few months and give Plaza Centers sufficient breathing room to realize the sale of its operating assets and further develop its extensive pipeline. Plaza Centers commissioned Baker Tilly, a well-known real estate appraiser, which performed a liquidity analysis and outlined a specific timeline for its asset realization plan. We believe this is a realistic plan that will comfortably settle its outstanding debt obligation and provide adequate liquidity for operations. As evidence of the Company’s intention to follow through with this plan, in November 2013, the company sold Koregaon Plaza for cash proceeds of 16mm EUR.

Sum of the Parts Valuation

In order to value Elbit Imaging, we used a sum of the parts valuation. To do so, we calculated the net asset values of the operating subsidiaries that were attributable to the holding company, then accounted for net debt and holdco opex to determine fair NAV per share. Our analysis indicates a long position in EMITF will provide a -33% return in the low case, a 62% return in the base case and a 175% return in a high case.

Plaza Centers NV

Elbit Imaging owns 56.9% of Plaza Centers. Plaza Centers NV value comes from commercial real estate assets in Central Europe, Eastern Europe and India. Plaza Centers has six operating shopping and entertainment centers in Poland, Czech Republic, Serbia and Latvia with an aggregate store size of 161,000 square meters, as well as 19 real estate development projects (2 through Elbit Plaza India) with an aggregate plot size of 521,786 square meters in CEE and India. The company also owns a large real estate development project in Romania, Casa Radio, which has a plot size of 555,000 square meters.

The industry standard in commercial real estate is to have both operational and development assets appraised yearly in order to determine the value of the assets to be recorded on the company’s financials. The company then marks its assets at the lower of historical cost or the appraisal valuation. This has been exceptionally important since the financial crisis, as companies in this space have had to mark significant write-downs to their real estate assets which were purchased at peak prices. Based on Plaza Centers’ most recent (as of December 2013) appraisal valuation by Cushman Wakefield, its real estate assets are now marked to ~$730mm on its book. This implies that the market is valuing Plaza Centers’ assets at 0.76x this valuation. In November 2013, as part of its restructuring negotiations with creditors, the company commissioned another appraiser, Baker Tilly, to appraise its assets in order to determine a feasible capital structure and an asset realization plan for the company. Baker Tilly determined that the company’s assets were worth approximately $758mm. Similarly, the market is valuing Plaza Centers’ assets at 0.73x this valuation. Our view is that the market is over-penalizing Plaza Centers’ book as a result of annual write-downs of its real estate assets and the current restructuring overhang, providing an opportunity to buy these assets at a bargain.

All of our cases give full credit to Plaza Centers’ seven operating assets, using Baker Tilly’s appraisal valuations. We were able to sense check these appraisals as the Baker Tilly report provided net operating income disclosures for each of the assets and the implied cap rates used to value the assets were reasonable for each of the geographies. The weighted average cap rate (weighted by value) for the operating assets is 6.93%, which we believe is reasonable from looking at other commercial retail properties in similar geographies. In total, the operating assets are worth $360 million.

The low case values the remaining 18 development projects at firesale liquidation valuations provided by Baker Tilly, totaling $160mm. The base case assumes that only two development projects will be moved forward (Sportstar Belgrade Plaza in Serbia and Lodz Plaza in Poland), as outlined by the company’s asset realization plan, creating an incremental $51mm of value compared to liquidation. The high case assumes that four development projects will be moved forward, creating an incremental $117mm of value compared to liquidation. In addition to the base case developments, Belgrade Plaza in Serbia and Timisoara Plaza in Romania will be moved forward in the high case. We want to emphasize the magnitude of the Casa Radio development project in Bucharest. Cushman Wakefield estimates its value upon completion at $858 million, however management highlights that significant investment must be made in order to complete this project. As such, while this project could be a source of significant potential upside, for the sake of conservatism, we marked a liquidation valuation in all of our cases.

Given York and Davidson Kempner’s involvement in the company’s board, we are comfortable underwriting that the company will focus on only investing in projects that provide an adequate risk-adjusted return and sell the remaining projects as-is over time (likely above the firesale liquidation valuations we are using). Plaza Centers has other assets of $51.2 million, which includes cash and equivalents and proceeds from the sale of Koregaon Park. It also owns a 47.5% stake in Elbit Plaza India that we value at zero in our base case, $32mm in our base case and $75mm in our high case. The methodology for this valuation will be discussed in the “Elbit Plaza India” section.

Plaza Center’s total indebtedness including project level bank loans, Series A and B Debentures and Polish Bonds is $491mm. Elbit Imaging owns 56.9% of the current equity in Plaza Centers. Given that the current restructuring negotiation’s most recent proposal gives 13.5% of the equity to creditors, we account for this dilution in our valuation. We also account for $82mm of capitalized overhead at Plaza Centers.

Elbit Plaza India

Elbit Imaging holds a 47.5% stake in the India subsidiary. Plaza Centers also owns a 47.5% stake in the venture and we account for this value separately through our Plaza Centers valuation. In our low case we underwrite zero value. While this scenario is unlikely, we consider this scenario because in its 2012 20-F, Elbit Imaging expressed concerns that EPI may face “restrictions on selling an undeveloped land without governmental approval” due to Indian FDI policy.  In our base case, we underwrite $32mm attributable to Elbit Imaging directly, which is based on land values of Chennai and Bangalore from the CW appraisal. In our high case, we underwrite $75mm, which is based on the land value of Bangalore and market value upon completion of Chennai from the CW appraisal. We believe that EPI will move forward with the Chennai project, as outlined in the BT asset realization plan. Our “It Could Happen” Case realizes completion of both India assets. In such a scenario the total assets of the JV would be worth $666mm, which implies an average of $392,000 per apartment. Based on our research of property prices in Bangalore and Chennai we are comfortable in the accuracy of this estimate. Our concern is the ability to see both of these projects through, but investors should be aware of the potential for enormous upside here.

Elscint Holdings

In order to value Elscint Holdings’ three operating hotels we used net operating incomes as disclosed in company filings. NOI for Radisson Blu Antwerp, Park Inn, and Radisson Blu Bucharest in FY 2013 was $4.1mm, $1.4mm, and $13.5mm respectively. For our Radisson Blu high case we used company’s guidance for FY 2014 NOI of $16.5mm. Interestingly, this number along with the actual 2013 NOI can only be found by digging through company filings in Romanian. For the operating hotels we applied cap rates in the range of 7-11%, which again we believed to be conservative relative to our research on comparable cap rates for luxury hotels in Romania and Belgium. We valued Elscint’s stake in Park Plaza using a market valuation based on PPHE publicly traded stock, the loan face value received, and an estimate of option value. We marked Tiberias assets at zero in our low case, a 50% haircut to the Kanne appraisal value in our base case and the full Kanne appraisal valuation in our high case. The reason for our conservatism is due to the lack of disclosure related to the Tiberias assets. There may be an opportunity for management to spin out Elscint Holdings as a standalone REIT, creating further value for shareholders. For an overview of the Elscint valuation see the scenario analysis breakdown below.

Elbit Medical

In all cases we underwrite the value of Elbit Imaging’s stake in Elbit Medical at its current market valuation, $119mm, plus the value of its intercompany loan to Elbit Medical, $43.5mm. In the Elbit Imaging’s most recent filing, it writes “the corporate organs of the Company, as appointed after the closing of the Arrangement, will be assigned the task of examining the issue of realization of the Company's shares in Elbit Medical Technologies Ltd. ("Elbit Medical").” This indicates the Company’s commitment to realizing the full market value of Elbit Medical.

In recent months the company has publicly acted upon this statement. On March 18, Elbit Imaging announced that Elbit Medical received a non-binding proposal for Gamida Cell with consideration including “a payment of a significant amount upon closing, as well as certain milestone-based payments…expecting to amount up to several hundred million dollars.” The Israeli newspaper Globes identified Novartis as the buyer and suggested that the upfront payment was $150mm and the contingencies amounted to ~$450mm. On April 13, 2014, Insightec received a term sheet from a non-current investor to invest “a few dozen of millions of dollars based on a company valuation significantly higher than the company valuation set on the previous round of capital investment in Insightec”. The last post money valuation for Insightec was $105.9mm in December 2012.

Retail & Other

Our valuation of “other” is zero in the low case, $7.2mm in the base case and $14.4mm in the high case. The most recent Elbit Imaging financials show $2mm in operating profit for its Mango retail stores in Israel. Elbit Imaging has a contract with Mango that expires in June 2015. Elbit Imaging has the option to extend its store leases for up to 10 years, but the Company’s ability to renew its operating contract is uncertain. The Kanne appraisal values Mango at $14mm, which implies a reasonable 7x multiple if we assume contract renewal. Since this is not certain we cut the multiple in half in our base case for conservatism. Additionally, our valuation of “other” completely ignores any value attributable to Elbit Imaging’s investment in Olive Software (18.33% ownership) and Varcode (52.4% ownership). Again, these investments only represent additional upside that we have not included in our valuation.

Summary of SOTP Valuation

The summary of our Elbit Imaging equity valuation and our scenario analysis is above. We calculate -33%, 62%, and 175% returns in our low, base, high respectively. There are also home-run scenarios that could return many multiples on your money. Given the disparate assets and multitude of possible realization outcomes, we do not view our cases as discrete outcomes, but instead use it to highlight a spectrum of potential returns. Because real estate development projects take time to develop and their value upon completion is not clear today, we can’t provide an exact number for what we think the company will eventually be worth. We feel that the most likely outcome is somewhere in between the base and high cases representing an approximate doubling of invested capital as the market re-rates the company’s book value.

We view our low case (in which you lose 33% from current levels) as quite bearish. It values the company’s current operating shopping centers and hotels, accounts for the market value of the medical subsidiary, while liquidating 18 of its development assets at firesale prices and attributing no value to its India and “Other” investments. Our base case and high case rely on only two (2 CEE) and five (4 CEE, 1 India) development projects moving forward, respectively, which we believe fall in a spectrum of reasonable expectation based on company guidance and the economics of those projects. Finally, there is home-run potential for this investment if the company does not just run-off most of its book but instead moves forward with more of its 13 other development projects (our valuation does not even including the massive possible upside of the Casa Radio project).

Risks

There are a number of risks to take into consideration with this investment. There are obviously macroeconomic risks here relating to the economies and real estate markets of CEE and India. This is mitigated by the company’s diversified portfolio across geographies, with its six shopping centers spread across Poland, Czech Republic, Serbia and Latvia, and its three hotels spread between Romania and Belgium. Many of its development projects are in countries in which Elbit Imaging does not currently operate, including India, further diversifying its portfolio. After years of asset write-downs, we believe Plaza Centers has finally marked its book close to fair values and yet the market is giving its book only 76% credit. We reiterate that do not have a strong view on these real estate markets but view this mix of assets as trading at a steep discount to fair value.

Elbit Imaging’s stake in Plaza Centers poses a risk to investors due to its ongoing restructuring negotiations and its high degree of leverage. While the most recent proposal indicates an “amend & extend” for creditors with a 13.5% equity dilution to current shareholders, it is possible that the creditors negotiate for more equity, further diluting Elbit Imaging’s stake in Plaza Centers. It is even possible that the creditors try to force PC to liquidate; however, we view this scenario as highly unlikely both as it would destroy value and would be vetoed by shareholders, specifically York and Davidson Kempner (both through Elbit Imaging’s stake and Davidson Kempner’s outright 5% ownership in Plaza Centers’ equity).

Finally, there is some risk associated with the value of Elbit Medical. Since we cannot independently value these businesses, we rely on management’s ability to realize the market value of this subsidiary. While we are comforted by management’s language in the recent filing about realizing the value of this subsidiary, this is a risk that is inherent in this investment that cannot be easily hedged (long EMITF, short EMTC) due to leverage at the holding company, Elbit Imaging.

A Note on Plaza Centers

We believe Plaza Centers’ equity also represents an attractive risk/reward and can be purchased on the London Stock Exchange (ticker PLAZ). However, assuming our base case assumptions for all other Elbit Imaging assets, by purchasing equity in Elbit Imaging you can actually create Plaza Centers at a discount to its current market value. This allows you to receive exposure to Plaza Centers at a discount, while still benefiting from the decreased risk of owning the diversified holding company. 

Catalyst