So first blog post. About a German stock.
Why not start with what is perceived to be the blackest of black boxes, the hardest from the ‘too-hard’ pile?
Corestate Capital (ticker CCAP). There’s levels and levels to this stuff. The founder, the acquisitions, the debt, HFS, the shortsellers, the CEOs, Covid. This will be a multi part series.
Let’s start with the basics: Corestate is a real estate asset manager, predominantly active in Germany. What are they doing? Well, they acquire, manage and sell real estate assets / investment structures on behalf of clients.
How do they make money? Well, they charge fees for the activity mentioned above.
A lot of fees. It reminds me of the quote from Charlie Munger: ‘Warren talked to a guy at an investment bank and asked how they made their money. He said, “Off the top, off the bottom, off both sides and in the middle.”’
Off the top, off the bottom, off both sides and in the middle is how Corestate generates their fees.
So in the real estate business, with the German economy doing just fine in the last couple of years and interest rates negative, what could possibly go wrong?
Well, judging by the share price development since IPO in late 2016, a lot it seems:
Let’s back into this with some numbers:
We will go into the details of the P&L in a later part of the series, but you will note the business did grow and is highly profitable, generating EBITDA margins of >50%. OPEX mainly consits of personnel expenses. On the balance sheet side, there is debt, a lot of it (€600m), primarily stemming from the large acquisitions of HFS, Atos, Hannover Leasing in 2017. In 2018 and 2019, Corestate pursued a growth & dividend strategy, acquiring smaller bolt on targets and paying out 60% of net profit as dividends.
So what do we have:
- A highly profitable business, but operating in a cyclical industry
- Tremendous operating leverage, in a cyclical business: Their cost structure is mostly fixed (PEX), only c15% is variable
- Tremendous financial leverage, on top of operating leverage, in a cyclical business: €600m of debt on the balance sheet
- Dividend policy to pay out 50% (no intent to reduce leverage)
- Acquisition of smaller RE asset managers (no intent to reduce leverage)
- Focus on the high risk/reward parts of the RE market: Value-add and opportunity segments
Not sure if I could make it clear but this is insanity, pure and simple.
And I forgot to mention: They do not only make money by charging fees, they also invest alongside clients in the equity of their real estate structures (alignment capital), and receive dividends and gains when the value of the structures appreciates.
Now see the working capital movement and investing cash flow in the FCF table:
What that means: They loaded the boat in the alignment capital business in FY19, taking additional equity exposure to the real estate market, betting on an excellent FY20 and beyond. And of course, exposure in their specialty, the risky value-add and opportunistic segments.
Then Covid hit.
Now the Value-add and opportunistic market is shell shocked, frozen. Acquisitions dry up, as clients stay away from these sectors. Losses in the alignment capital investments they loaded up on.
In the first 9m 2020, revenues down 30%, but EBITDA down 60%. Operating leverage. (OPEX actually increasing yoy). Financial leverage now all of a sudden 6x EBITDA. Oops.
To survive without asset firesales, they not only cancel the dividend but raise capital from largest shareholder Ketterer family and announce a new CEO, to start in Jan.
But in a surprising turn of events, in October, a month after the cap hike, the Ketterers through in the towel and sell all their shares. 10% now owned by Vestigo Capital. Ketterer reps in supervisory board step down, along with the whole supervisory board, supposedly to avoid a stalemate situation with the new Vestigo reps. Despite only owning 10% of shares o/s, Vestigo now controls the supervisory board. The new CEO, (former long time COO of larger peer Patrizia) who was supposed to start in January is cancelled, current CEO who was supposed to leave the company will now transition to his old role as CFO and a new CEO has been hired.
If I count correctly, the new CEO is the 4th CEO … in 4 years since CCAP IPOed.
So here we are: The major stock indices are making new all-time highs daily, even Covid impacted stocks are flying. CCAP is trading at 52w lows, printing lower highs and lower lows. A falling knife. The market is telling you very loud and very clear, to not walk, but RUN away, as fast and as far as you can.
And it’s very understandable:
- New lockdowns in Germany, perception of further impact on the RE transaction market in general and value-add and opportunistic in particular
- Terrible yoy financials 9m 2020 60% decrease in EBITDA, net profit down 90%
- Leverage ratio seemingly out of control, market cap < debt
- Ketterer, RE czar, intimately familiar with the business, throws in towel
- New CEO has neither RE asset mngt nor public company experience, used to run a tier 3 broker house
- New 10% shareholder controlling the board, agenda unclear
- Terrible sentiment: (Retail) investors have been fleeing the stock, sheer panic when the stock dipped below 12 late November
And historically, the market has been right on Corestate. High div yield, market signaling profits are not sustainable.
I am now going out on a limb and will claim the 4 most dangerous word in finance: This time is different.
Leverage cuts both ways.
To be continued.