Description

Disclaimer: This report is the work of an investment adviser affiliated with the author. The report is the result of the adviser executing its investment strategy. The adviser holds a position in the security, however there is no assurance that the adviser will continue to hold the investment, or make additional investment and will not update the information to reflect future changes in the adviser’s assessment of the investment.

Renta Corporacion (REN SM) emerged from bankruptcy protection in 2014 and began trading again in late 2014. The company is run by Luis Hernandez de Cabanyes, a hard-charging, dynamic entrepreneur who is considered to be one of the best operators in the property sector in Barcelona and Madrid. In the previous cycle he built Renta to over a 1B Euro market capitalization company. We’ve always found top operators in small companies (Renta’s current market cap is ~ 100M Euro) to be a good place to look. While Luis is strong in his field, he made two key mistakes in the last cycle which led Renta to go bankrupt. First, he used significant leverage to acquire properties. Secondly, he expanded beyond his core markets of Barcelona and Madrid to other European markets such as Paris and London where he has no edge.

While this led to a blow-up in the financial crisis, there are some positives to investing in Renta now. First, by all of our reference checks on him, Luis and his team have sworn off any leverage and are going back to the initial Renta asset light model that allowed them success in the first place (discussed below) and their growth initiatives are also all capital light. Second, they are focusing only in their core markets. Third, numerous people who know Luis well have told us that he feels a deep humiliation for Renta having gone bankrupt and his sole professional mission is to build Renta back up to its prior greatness. On this note, a Spanish bankruptcy is a long and arduous process, and Luis could easily have given up Renta to the creditors and just start a new entity. Because of his passion for the company, he went through the full process (several years in duration) and as mentioned finally got his company back in 2014. One additional benefit that is not lost on us or him is Renta now has a massive net operating loss carryforward (nearly 300M Euro).

We think Renta is interesting for two reasons. First, the broader context above and the bet on a jockey. Secondly, a bet on the specific valuation at hand and a special situation. While Renta’s price is appreciating due to recent actions Luis has taken and liquidity is improving, there is still limited to no sell-side coverage.

In terms of the valuation, we can break it into three parts:

• Core business
• b)      Net operating loss carryforward of 290M, no expiration.
• c)       Newly launched REIT which Renta is the manager of.

The core business is what Renta has done for more than 25 years and is what they are specialized in more than any other player in their markets. Renta focuses on residential properties and hotels in Barcelona and Madrid that have something wrong with them: low vacancy, not the correct zoning, title issues, etc. They go to the owner and give them cash for an option (usually less than a year, sometimes longer) where during that period they can buy the property at a set price. They use that period to try to fix the deficiency and then flip it, keeping the spread for themselves. The option payments are tiny relative to the property value – the proposition to the owner is not so much the payment but the ability to sell the property to Renta at a higher price than he can get elsewhere because he cannot fix the deficiency himself.

This model is not dissimilar to asset management. It is about finding inefficiencies in the market and using their best in class knowledge, expertise, contacts, relationships with buyers, city officials, lawyers, etc. to add value and make an arbitrage. Like asset management, it’s choppy and unpredictable. This model produced 4M Euros of after-tax profit in 2015, ~ 1.5M in 2016, and a guided 9M in 2017 (much of this is relatively secure given it’s based on sales under contract but not yet closed).  The Spanish election freeze in 2016 impacted that year and likely pushed some sales from 2016 to 2017, so an average of those two or ~ 5M Euro may be reasonable. Since it’s asset management, we don’t think a high multiple should be used. We use a 10x P/E multiple to get to 50M Euro in value.

On the NOL, there is 290M to go and there is no expiration date. Given the Spanish tax rate of 25%, there is 73M of value here undiscounted. 16M of this is already on the balance sheet but as profit grows they could recognize more of this and the CFO has indicated the auditors restrict how much can be recognized to the business plan for the next 5 years only (which indirectly gives you some sense for the strong net income growth the company is hoping to achieve internally). For now we use 20M Euro for this asset as we do not want to double count by requiring part three of our valuation to be successful for this part to be accurate. 

So so far we have 70M Euro out of the 100M Euro market cap covered. This gives us low cost optionality on the most exciting part of the story. Renta announced several weeks ago that they are being funded by the pension fund in the Netherlands to launch a ~ 150M Euro REIT to acquire residential properties in Spain. This will be the first Spanish REIT in the residential sector (there are multibillion Euro REITs in Spain in other property sectors and multibillion Euro REITs in the residential sector in other major European markets). The Dutch pension fund has informally committed another 150M Euro later this year, and given the REITs planned 1:1 leverage this gives 600M of purchasing power by early 2018. Renta plans to list the REIT by late 2018 and raise further equity to bring gross asset value (debt + equity) to over 1B Euro by end of next year/early 2019. From there they hope to keep growing the REIT into the multi-billions.

Using 1B Euro for now, their fee structure is 0.3% annual management fee on gross asset value, 1.5% on all acquisitions, 1.5% on all dispositions, and 20% performance fee over an 8% hurdle.  Putting aside the performance fee as an additional upside, the management fee portion alone would yield 2.3M in post tax profit which should get a high multiple as it is truly recurring as the REIT would be a permanent capital vehicle. All the costs for the REIT are borne at the REIT level so the mgmt fee to Renta the manager is essentially pure profit. One can see a 15x or 20x P/E multiple to this stream. At 20x that is 45M Euro in value.

Given a 5 year anticipated holding period, the acquisition and disposal fees on average over the 5 years generates 4.5M Euro of profit per annum which is recurring as after the 5 year period, it’s a permanent capital vehicle so Renta can do the same thing again. At 15x for this stream, that’s 68M in value, although Renta has not yet determined what % of the assets will be bought and sold within 5 years and what % will just be bought and kept for the long-run. The more of the latter obviously reduces the 68M.

The performance fee on 1B Euro in size can be big obviously as further upside should the cycle go well. 

Then if one can take all of these fee streams by 2 or 3x given the multibillion Euro size potential, one can see a nice growth story developing over the several years. We are confident that if the REIT goes public in late 2018 and is 1B Euro in gross asset value, the market will discount some of the growth potential to 2-3B before it happens. And while there is risk the REIT doesn’t go public and remains a smaller private REIT, the value of this plus the core business plus the NOL covers you. The big picture is managing a residential REIT for Renta makes a great deal of sense: they are one of the top management teams in the residential sector in Spain, the sector is improving, and there is a hole in the market currently. Finally, it shifts Renta’s earnings from a more lumpy core business today to a significant recurring mix, so not only will earnings grow but the multiple the market will give it will grow.  

Some other notes on valuation:

First, they have some owned assets and some debt, all of which is a legacy from the bankruptcy. These roughly cancel out.

Second, a couple of years ago they did a 55M Euro JV with the large asset manager, Kennedy Wilson, where they will get a performance fee when they monetize the assets in the JV. This could be several million Euro to Renta, but the bigger thing to us is Kennedy Wilson choosing Renta as their local partner in Spain is further testimony to Renta being a top local operator.

Third, there is optionality on what Luis does from here. We have heard from management that they are exploring now that the REIT is off the ground a 50M initial real estate private equity fund. While this is small to start at least, it shows two important things: a) management is thinking only in asset light ways and b) management is dynamic and committed to finding ways to grow the business. This isn’t surprising given Luis’ mission to restore Renta to its former glory. We think more is to come.

There are risks, the biggest being Spanish macro/property cycle. Many observers say given how deep the Spanish property crash was, there are still years of improvement left and we are in the sweet spot of the cycle. We don’t have a strong view here and are actively thinking of using the current frothy markets to find a cheap hedge and not have to worry about it. We will update the board with what we find. 

Catalyst

Growth in REIT AUM

Launch of new PE fund 

Hitting 2017 guidance