Description

 Trading at 0.8x book value (versus peers at 1.6x) and 8x 2012 earnings, Inpar is a Brazilian real estate developer with a history of mismanagement that recently underwent a change in management and shareholder control.  For the first time in years, Inpar is now positioned to resume a steep growth trajectory.  After its 2007 IPO, Inpar quickly invested the majority of its R$750mm of proceeds, which left the Company in financial distress when the financial crisis hit.  Then in 2009, real estate fund Paladin (30 projects in Brazil, been investing for 15 years) injected R$180mm and diluted shareholders by 50%.  The Company is now well-capitalized and should grow earnings by 75-85% per year through 2012 and improve its ROIC from basically flat (2008) to the mid-teens.  Drivers of the improvement include a more efficient operational structure (margins currently 600bps below industry average) and capital flexibility to buy and sell land at normal levels after a period of financial distress.  Based on these dynamics, Inpar offers 150% upside in the next year or two if new management and the new controlling shareholder, can continue to execute the strategic plan. 

Business Overview

I will keep this part brief as adequate information is available on the company's website (http://www.inpar.com.br).  Inpar is a real estate developer and builder with 15+ years of experience in the Brazilian real estate market.  Operations are predominantly focused on the residential market (middle and low income segments) and Inpar's land bank has ~R$11.5bn of sale value (65k units).  The Company states that the short-term land bank (defined as being used in projects over the next 18 months) is approximately R$3.5bn in total sale value across 21 cities in 9 Brazilian states.  43% of the Company's land bank is suitable for developing projects targeted to the middle and low income segments through the brand Viver (Inpar defines low income as sub R$250k, R$3250k-350k as middle income and R$350k+ as high income).  22% of Inpar's land is eligible for Brazil's Minha Casa, Minha Vida program - a government-sponsored program encouraging home ownership across the country.  Read about it in more detail here: (http://obeliskinternational.blogspot.com/2010/04/minha-casa-minha-vida.html).  The quick summary is that the program was started in early 2009 with a R$34bn budget with the aim to reduce the property shortage by 14% (goal of 1mm homes).  The financing comes from government-owned Caixa bank and provides buyers with 100% financing for up to 30 years at a 5% interest rate.  This is not bad given that said rate is lower than Brazil's government bonds!  Additionally, mortgage payments are guaranteed for up to 3 years.  The program is targeting 400k homes for individuals and families that earn between 0-3x minimum wage (currently R$465/month), 400K homes for 3-6x minimum wage and 200K homes for families earnings 6-10x minimum wage.

In the next several years, 80-90% of new launchings will be in the low income (sub R$250k per year) from the Viver segment.  Here is an illustration of how a launching works.  Using a piece of land with  R$100mm of sales value potential: 1) cost of land is R$15mm (15%), 2) construction cost is R$50mm (50%), 3) other expenses such as marketing, commissions to brokers, etc are another R$15mm (15%) which leaves a profit of R$20mm.  Typically the banks finance 80% of the construction cost (R$40mm) and real estate financing accounts for another R$40mm which leaves R$20mm of equity investment for a R$20mm profit.  The time horizon is on average about 2.5 years, which implies a 30%+ IRR on a new launching.

History of Inpar

Inpar was established in 1992 by the Parizotto family (the same family that established well-known retailer Atacadão).  The  Parizotto family had significant experience searching for land for retail stores so the shift to real estate was a natural one.   Inpar officially began operations in 1992 as a middle-income real estate developer and, several years later, began diversifying into office, tourism, and other areas.  In 1999, Inpar launched its first low-income project with the "Viver" brand and became a multi-segment business with residential, business, tourism and lot development segments.  The Company went public in mid-2007 with a R$750mm IPO and was listed on the Novo Mercado.  Previous management and family-owners over-levered the Company and Inpar found itself in a cash constrained pickle when the market collapsed in 2008. 

The Paladin Influence

In December 2008, Paladin Prime Residential Fund subscribed R$180mm in Inpar's capital increase and became the largest shareholder.  Paladin is a US-based real estate fund with 17 years of experience investing in Latin American real estate ($5bn fund).  After participating in another equity financing in February 2010, Paladin now owns 40%.  The shareholder base now consists of 46% float, 40% Paladin and 14% former controlling family.  Inpar is the ONLY large corporate stake held by Paladin and Paladin now has 4 of 7 board seats.  We expect Paladin will not exit its position until 2018.  In fact, Paladin was buying shares at the current price back in February.  Since taking its stake in Inpar, Paladin has made many steps towards turning around the previously flailing business.  Paladin has dramatically changed the corporate organizational structure in the last year, including a) reducing the number of executive officer positions from 11 to 3, b) installing a new CEO (formerly CFO of EVEN3.BZ during its IPO) and new investor relations head, c) cutting G&A expenses from R$90mm in 2008 to R$67mm in 2009  and d) reducing the involvement/influence of the former controlling family from 4 members to 2 (two former guys are currently Head of Sales and Head of Operations, respectively).  Operationally, Paladin curbed cash consumption and shored up the Company's financial position.  Specifically, Paladin cut launchings to zero (cash burn went from R$120 in 4Q08 to R$48mm in 4Q09 and Inpar is now FCF positive).  Additionally, inventory was cut in half and tertiary non-core assets were sold for R$200mm.  Finally, Paladin was able to secure financing for all new projects to avoid the need for further cash burn.  This included renegotiated debt and land payment schedules to reduce near-term maturities from R$618mm to R$380mm.  It is also worth mentioning that the new management team was just awarded an option program providing them with 3% of the equity, a very meaningful figure for this team.

Market Dislocation

Many of Inpar's legacy shareholders still have a terrible taste in their mouth from the machinations of the last several years under previous management.  The Company was terribly mismanaged and the penalty for their folly was equity dilution in excess of 50% in aggregate.  While the stock has recovered 35-40% from its trough, Inpar still trades at a massive discount to peers and a 20%+ discount to a book value that we believe understates the true value of the real estate.  Management has delivered on its targets so far and we expect that R$1.3-1.5bn of launchings and R$200-250mm of operating cash flow in 2011 will crystallize the opportunity for value creation.

50% of the land bank is called Lagoa.  It is a piece of land about 25% the size of Manhattan, located near Belo Horizonte in Minas.  Skeptics have ascribed no value to this land bank and argue that it will not create value for Inpar.  However, management recently shared that Inpar just launched its 3^rd project in this area and it sold for R4k per square meter, the same price competitors have commanded for land located IN the city of BH.  Management equates the development of Logoa to that of Barra de Tijuca, a formerly underdeveloped area near Rio de Janeiro, which is now a bustling commercial area.  Further, management explained that the land near Rio was, at best, average quality/value relative to the Lagoa land bank.  Using this valuation as a proxy for the entire land bank would suggest the land is worth 3x what it is currently carried at on Inpar's books.  Management wants to unlock the value of this land bank as soon as possible.  In a recent call, they shared that Inpar is considering forming a partnership whereby Inpar could sell 20% of the land bank at a value implying the land bank is worth 3x the current carrying value on the balance sheet.  This is expected to materialize in the next 6-12 months.  Even if you assign zero value to Lagoa, Inpar still trades at just 1.1x book value versus competitors' average of 1.6x.

Risks

Rising construction costs: construction has been a very hot market in Brazil due to growth in both residential and infrastructure build-outs.  The country is seeing price inflation on both materials and labor costs.  However, in Brazil, unlike in China, 100% of the inflation is passed on to the clients (not necessarily without a reaction in demand).  The risk here is that inflation gets out of control and that demand falls as clients do not want to bear the cost of inflation. 

Rising interest rates: Management claims that there is no correlation between the mortgage rates / RE financing rates and the SELIC rate. The reasons for this include a) real estate financing comes from savings in Brazil (versus leverage in the US and most other places), b) subsidized funding for commercial banks encourages them to continue lending to expand home ownership, and c) affordability would not be impacted much by a 200bps move.  However, if the tenure (which, for now, is increasing) decreased dramatically, that would be cause for concern.

Catalysts

• Increased sell-side coverage (a number of banks appear to be sniffing around)
• Unlocking Lagoa land bank value through a joint venture, partial sale or more successful sales, which values Lagoa at 3x its carrying value
• R$1.3-1.5bn in successful launchings in 2011 (up 50% year over year) - this is a show me story
• Earnings expand at 80% per year over the next 3 years
• Continued EBITDA margin expansion (already gone from flat to mid/high teens in several years)

Catalyst