Description

While SBB (Ticker: SBBB.SS) is not yet a household name, it soon will be and I believe shares are a buy with ~50% upside over the next 12 months. Over the last few years, SBBB has proven to be one of most explosive real estate stocks in the world (+38% 5 yr CAGR) and to be an “Advantaged Acquirer”. In March 2016, CEO and Founder, Ilija Batljan created SBB with the vision of building the best Nordic property company focused on social infrastructure properties and he surrounded himself with some of the highest quality real estate investors in the region.

Thus far SBB has had unbridled success with its playbook of buying, developing and managing social infrastructure assets (i.e. schools, hospitals, prisons) as well as rent regulated apartments in Sweden, where SBBB has competitive advantage in partnering with local governments and there are tremendous barriers to entry. This has allowed its NAV to grow from ~$7.5bn in 2016 to >$70bn in 2020 (post Hemfosa) or 10x growth in ~4 years while its EPRA NAV/share has compounded at ~37% per annum.   

SBB is on the verge of closing its acquisition of Hemfosa and becoming the dominant player in the Nordic social infrastructure real estate industry. The deal will lead to 2x asset and market cap growth as well as $300mn synergies in Year 1. It effectively makes SBB the 4^th largest RE company in the Nordics, which is impressive considering the company was only formed ~4 yrs ago!! In addition, assuming just a 20x P/E for synergies this would add $6bn SEK ($300mn * 20x) to SBB’s valuation.

Yet there remains a pretty large knowledge gap and just a few Analysts cover the name, but this should increase dramatically over the coming months. While there are many moving parts, I think when coverage is re-instated people will see that SBB is only trading at ~15.5x ‘20 cash P/E and ~13.5x ’21 cash P/E. This compares favorably to a real estate industry avg of ~21x forward P/E and I think SBBB should trade at a premium. Also, the shares remain under owned by larger institutions that you’d typically see in key Nordic real estate names.

In addition, SBB owns some of the best assets in the world; social infrastructure in the Nordics, where ~95% of revenues come from direct or indirect government entities. This is a unique asset class as leases tend to be longer than any other asset (10-20 yrs) w/ CPI rent adjustments as well a very low vacancies (~100% occupied ex-renovations). These assets are truly recession resistant toll-roads as they are backed by sovereign counterparties with AAA ratings and are not able to default.

Also, one must be Swedish to buy these assets, so you can rule out competition from global real estate players like Blackstone, Simon or Brookfield. This allows SBB to acquire most of its assets “off market” and away from competitive auctions. Lastly, as an emphatic vote of confidence the CEO, Ilija Batljan, put another $500mn SEK of his own capital into a December rights offering at ~5% higher share price than current.

Company Overview

New SBBB will have ~$70bn SEK of assets at the time deal closes. 94% of rental income will be coming from social infrastructure assets in the Nordics with ~75% in Sweden, ~18% in Norway, ~7% Finland.

In addition, ~78% of assets are tied to Community Services, ~15% are tied to Regulated Residential and ~7% Other, which are usually renovation projects making the transition to becoming social infrastructure assets. ~60% of the value of its property portfolio is in the Nordic region’s largest cities with Stockholm as the largest market

Community Services Property (78% of Rental Income):

SBBB’s largest exposure is to Community Services, where the asset class is defined by low risk publicly financed tenants, long leases (10-15 yrs) with low turnover and attractive lease terms. In terms of exposure, its largest categories are elderly care, group housing for people with disabilities, schools and hospitals. SBBB on average has ~7 yr leases, which is amongst the longest on any publicly traded RE company, but most of leases are renewed in perpetuity.

In Sweden, ~80% of the $1 trillion SEK community services asset base are still owned by government entities, but 55% of new projects are being funded by private capital and this is a trend that SBBB should continue to benefit from.

Rent Controlled Swedish Residential RE (15% of Rental Income):

SBBB’s next largest exposure is Rent Regulated Residential properties in Sweden, with a focus on cities that have favourable demographics such as underlying population growth and high demand for housing. This is an asset class that is unique to Sweden as a structural shortage in housing has led to rent regulations and SBBB is well positioned to capitalize on the privatization of these assets which has just started to happen.

Rent controlled housing represents a sizeable market with high barriers to entry and strong opportunity for SBB to remain the partner of choice for local governments. Mr. Ilija Batljan, SBBB’s CEO started his career in this end market and has developed extremely strong relationships with regulators in these market as well as a strong track record of success. In fact, SBBB was recently the first private company to be named a member in the Sweden Housing Association.

Variant Perception

ü  Cash EPS: 2019 Cash EPS was ~$1.00, but new 2020 cash EPS is likely to be >$1.60 (vs. $1.25 consensus)

ü  Sustainability: There is an ongoing privatization and structural undersupply of community service properties driving industry growth, SBB will remain an Advantaged Acquirer and partner for municipalities for many years to come.

ü  Valuation: Trading at ~15.5x LTM P/E and ~13.5x ’21 PF P/E. This compares favorably to a Nordic real estate industry avg of >20x P/E and I think SBB should trade at a premium to the space

Price Target Overview

Using a blended average of Cash P/E and NAV multiples I arrive at a target price of ~$32.50, or a 50% upside including dividends over the next 12 months. Moreover, the combination of residential and community service properties is unique to the Nordic markets and there are limited comps in the region (only SBB and HEMF SS). I believe that these factors lead these assets to remain mispriced, but I don’t think this will stay true for long.

Given the fundamentals of these rental income / annuity streams and their growth potential, I would not be surprised if SBB were to one day trade similar to AIA.NZ (monopoly airport in NZ) at ~30-35x P/E. In a world of interest rates near 0%, SBB is extremely attractive as its credit risk is comparable to municipal bonds but it benefits from strong >10% organic growth and a 1-2% dividend yield. Given its current pipeline SBB has several years of renovations where they can borrow at ~1.5% and earn consistent >10% ROICs. Finally, not only are SBB (formerly Hemfosa) some of the safest assets, but they also have some of the best EPS growth rates (see Appendix).

For my base case, I am only assuming ~5% rental income growth in 2020 and 2021, despite typical >10% organic growth. In addition, I keep PF NOI margins flat at ~71.5%, which is conservative as a larger SBBB should be able to attain some scale benefits

On a P/NAV, SBB will be trading at ~110% vs. Swedish avg of >120%. Once again, I think SBB will trade at a premium (~130%), as they did before they announced the Hemfosa deal, and there are many drivers of very strong NAV growth going forward

Why is now the time to buy SBBB?

Transformative Hemfosa Deal Just Closed

On Nov. 15, 2019, SBB announced that they would acquire Hemfosa (HEMB SS), the #2 largest community service property company in the Nordics for SEK ~$23.5 billion (US$2.4 bn) in cash and stock via tender offer (~45% cash and ~55% stock). This was a ~22% premium to Hemfosa’s NAV and a small premium despite the strong potential synergies as Hemfosa shareholders would still be able to participate in value being created by the combined company.

The deal catapulted SBB from being the #14^th largest Nordic RE company to #4, while making SBB the #1 community service property “Champion” by a wide margin and the 800 lb. gorilla in an already consolidated industry.

While the two companies had many similarities, Hemfosa did not take part in rent regulated residential assets like SBB (~1/3 of previous SBB), but rest of their assets are tremendously complimentary allowing SBB to generate large scale benefits while rationalizing the market and getting rid of one of their largest competitors for bidding on assets acquisitions (especially in off market auctions).

Moreover, the SBB portfolio stands to gain from increased scale and diversification in terms of its cost of capital. In November 2019, SBB announced a $300mn post-tax synergies target to be completed in less than one year. ~$260mn of these savings would come from interest cost savings and ~$40mn will come from low risk duplicative overhead costs. While $260mn does sound like a large amount this only implies ~90bps interest rate savings on Hemfosa’ s $28bn SEK net debt. SBBB last borrowed 2 yr bonds at ~0.66%, while Hemfosa issued 3 yrs debt and was paying ~2.15%. By SBBB refinancing Hemfosa balance sheet, which is currently in progress, SBBB will be able to drive significant value creation. Assuming just a 20x P/E implies that this would add $6bn SEK ($300mn * 20x) to SBB market cap.

While SBB’s balance sheet did appear stretched post deal announcement at ~65% LTV, the company committed to de-leveraging to ~50% LTV in NTM and targeted rating upgrade to BBB+ by 2020 YE. The company also announced a $1.5bn B share rights offering, where the CEO took down $500mn of the offering and existing shareholders bought the rest at >$23 (or ~5% higher than current). As they say, “actions speak louder than words” and this is a strong vote of confidence for the deal.

On top of this, SBB stated that they would review Hermosa’s portfolio and look to divest non-core assets. Most assumed this would be office assets and happen sometime in 2020. Catching most by surprise, SBB announced last week that they found a buyer for ~$11bn in non-core assets and Nyfosa would be buying >$8bn assets at >115% of BV.

Knowledge Gap Is Set to Close

Another reason why SBB’s share are compelling right now is due to the large “knowledge gap” that exists in the name. Despite, SBB being one of the best performing stocks in the Nordics over the last several years it continues to fly under the radar. Part of the reason is because SBB listed just a few yrs ago via a backdoor listing and avoided an IPO roadshow altogether.

As it sits right now there are only 5 Analysts that cover SBB and 7 Analysts that covered Hemfosa, but only three overlapping brokers and there have not been any PF research reports. As SBB is in the process of closing the deal and bankers are helping them divest assets, most of the sell-side remains in the dark. Also, in looking at its current roster of shareholders one can see a complete lack of large traditional owners, and I think this creates a very favorable set up for outsized alpha over the coming months.

Moreover, it was only in late Sept 2019, when SBB’s B &D shares finally listed on the Nasdaq Stockholm’s large cap exchange and in late December 2019, SBB was finally added to the FTSE EPRA Nariet Global Real Estate, the premier European RE index. Over the next few weeks and months I think there will a virtuous cycle where new sell side estimates are refreshed higher, which drives new buying interest and inevitably SBB will become a name that most Nordic investors will need to have a view on.

Finally, through the various refinancing’s and proposed $11bn in asset sales, it appears that SBB may have achieved LTV <50% and its credit rating could be poised for a BBB+ upgrade >1 year earlier than they guided and most expected.

Investment Thesis

Highest Quality Real Estate Assets w/ Structural Competitive Advantages

Backed by SBB’s strong relationship with Nordic municipalities SBB offers a distinctive opportunity, unlike any competitor, to invest in community service and regulated residential properties supported by predictable cash flows and further augmented by additive recurring income streams from developments & transactions. The main attraction to SBB is its exposure to what they are offering, which are mainly community service properties (government funded tenants) within the Nordics, as well as Swedish rent stabilized residential assets.

Based on the fundamentals, I believe these real estate assets provide some of the most attractive risk adjusted returns of any real estate asset class in the world as they are essentially legal toll roads and fundamentally unlike other commercial real estate assets. The lease contracts are some of the longest of any asset class (>10 yr) with most leases being renewed in perpetuity, occupancy is ~100%, there are built-in CPI rent escalations annually and there are no break clauses. In addition, they benefit from low CapEx requirements and low taxes as the tenant is required to pay for most of the improvements via higher rents and community service properties in Sweden are not subject to real estate taxes.

On top of this these assets are recession resistant as the cash flows are not exposed to economic cycles and are ~100% backed by AAA state and local governments in the Nordics. Ultimately it appears like the credit markets are starting to appreciate the merits of social infrastructure assets given SBBB’s ~1.5% cost of debt, but it appears that the equity markets still have some education required to fully appreciate the quality of SBB’s asset base and its enviable position as the industry leader in a structural growth industry

Fast Growth, Compounder Roll Up / Outsider Mgmt

SBB isn’t just in a great asset class undergoing a transformative deal, the company has already put up one of the best performance track records in the Nordics since its IPO and it boasts one the best management teams in the region.

The founder and CEO of SBB, Ilija Batljan (~12% shareholder), is a former politician (with a PhD in demographics) and previously worked at Rikshem, a private property co in Sweden where he started to focus on the over-looked municipal market in Sweden. Mr. Batljan, developed a very good knowledge in how these municipalities work and how to do these deals, allowing him to capitalize on this unique opportunity.

SBB’s business development team is led by Oscar Lekander, who has carried out transactions for ~$100bn SEK throughout the Nordic region since 2010 and ~50% have been in community service sector.

Thus far SBB has had unbridled success and its position as an “Advantaged Acquiror” has only been strengthened by its acquisition of Hemfosa as they will now benefit from a lower cost of capital, increased scale and less competition. During 2019-2021, it’s my assessment that SBB will be able to deliver the highest annual increase in EPRA NAV among all Swedish listed property companies. Beyond M&A and synergies, there are many key fundamental drivers of continued strong EPS growth.

LT Secular Growth Opportunity Drives Multiple Drivers of Growth

On top of being an Advantaged Acquirer, SBB also carries out value-creating activities such as redevelopment and renovations of existing properties, as well as development of building rights and new communities as partners with the municipalities.

SBB has tremendous building rights and untapped growth potential that is not carried on its balance sheet. One of the most compelling opportunities is around renovations/upgrades. As rental income is dependent on standard of the properties, SBB continually seeks to implement improvements to its portfolio in order to pass along rent increases. Renovated apartments are judged to have a higher utility value, creating the opportunity to negotiate a significantly higher rent.

In general, SBB’s existing assets garner ~40-50% rent discounts to new assets and SBB closing this gap with each renovation project. As of right now, <15% of SBB’s portfolio is “newly” renovated and there remains a large upside to rents. SBBB has been targeting ~10% renewal of its existing real estate asset per year and proven a strong ability to realize 8-10% ROICs on these projects that they can fund with <1.5% cost of capital.

In addition, SBB aims to actively carry out property development where cash flow properties can be converted into residential buildings, or vice versa. In these cases, the acquisitions are most often made off market after SBB has held a dialogue with the respective municipality to ensure that the property with the local area is prioritized for upcoming urban development. This development process allows SBB to buy stuff at higher cap rates and convert them to social infrastructure projects that garner high rents and valuations. SBB can then chose to own them or sell the rights and raise cash.

As SBB upgrades these properties they benefit from higher rents and higher valuations. In the past SBB used to target $200-400mn SEK in annual development rights, but they have surpassed >$500mn SEK/yr. With Hemfosa, SBB will have >$2bn SEK of add’l value that can be released upon redevelopment that is not currently on its books. Lastly, there are strong secular growth drivers behind social infrastructure assets and the industry remains nascent. In Sweden, community service was ~9% in 2018 vs ~2% of total transaction volume in 2007. Throughout the Nordics, there is a structural shortage in housing and social infrastructure assets and municipalities are required to support an increasingly elderly population which is driving cash strapped municipalities to partner with private partners like SBB.

Investment Risks

·        Rising interest rates lead to multiple compression across real estate names

o   Mitigant: SBB’s cost of capital is fixed and hedged. The dramatic growth in EPS will overwhelm any slight change in valuation

·        Synergies/Integration

o   Mitigant: Most of synergies are tied to cost of capital arbitrage and not prone to execution risks

·        Change in Social infrastructure policies

o   Mitigant: Municipalities are increasingly turning to private partners to alleviate demographic pain points and reduce tax payor liabilities

·        Increased Competition

o   Mitigant: Investors must be based in Sweden, which eliminates most global real estate players. Municipalities are more focused on outcomes, not investments. As long as SBB continues to excel than they should remain a strong LT partner

Catalyst

Closing Hemfosa deal. Bullish Analyst coverage launch. Closing $11bn SEK asset sales. Credit rating upgrades.