Note:This is a relatively short note to provide members of VIC to assess the virtues of buying shares of Realia (RLIA SM) to gain rights to participate in the company’s share offering. The share to right issue ratio is 1:1. The offering will be at a ratio of 3 new shares for every 11 rights. I also believe the story is straight forward.
Background: Realia is a real estate firms in Spain that was saved by Carlos Slim from the hand of creditors. Slim currently today owns ~70.6% of the company (directly through Grupo Carso, and his construction firm, FCC). In 2015, Realia had €1.7bn in debt and was beginning to shed inventory of finished homes and land at a loss to survive. Slim gave the company emergency funds to operate, sold non-core office buildings and raised€236mm in capital. Today, the company is stable and in growth mode. It has €672mm in net debt with 66% of its debt maturing after 2023 and manageable leverage of 37%. It has been buying land opportunistically, has hired people to build its homebuilding business - its first since 2008. It is planning another (controversial) capital raise to accelerate growth, further reduce debt and be positioned to buy office assets in a market softening.
Description: Realia today is comprised of high-quality, cash-flowing office buildings and high-traffic shopping centers in Madrid in and Barcelona. In the residential sector it retains inventory from the 2008 crisis of 319 homes and 1.9mm m2 in buildable land, one of the largest land banks in the country.
Thesis: Realia is an undervalued asset run by one of the best capital allocators in the world, Carlos Slim. Investors would be paying a portfolio of cash-flowing office buildings in Madrid and Barcelona (where rates are rising), but would buy its land bank for free. We believe the land bank is one of the highest-quality and largest land banks in the country; moreover, we believe the housing market in Spain is in the first stages of a multi-year recovery cycle.
Spain’s commercial and residential real estate sector has been undergoing a strong recovery after the worst economic crisis in the country’s modern history. Realia is a way to play both sectors. Given that this is a relatively illiquid name, there is no Wall Street research.
Carlos Slim likes that there is no research – he wants to keep the company to himself. He tried to buy 100% of the company but was rebuffed by a handful of shareholders that know the real value. The company’s financials are sandbagging the opportunity, but even then, at €0.94 it trades at a significant discount to Realia’s last reported NAV of€1.32 in 2H18.
Realia announced that they are raising €149mm or 175.5mm shares (a 21% dilution) at €0.85 on December 17th. With this new share count, the NAV would be €1.04 - per Realia’s previous calculation – or 18% higher than the offering price. We believe that Realia’s true NAV is close to €1.6 even after the new share count.
Our valuation is based on the commercial real estate business being worth €1.09 after minorities, based on FFO for 2018 at the same yield as its peers. We assume no value for the housing inventory. The overlooked value is the land bank, which is high quality and will be developed. We believe the land is worth at least €0.90.
Realia was a spin off from Bankia, a government-owned bank. At the time, the company’s land was valued on an archaic accounting method used only in Spain to find the liquidation value of the land (Orden ECO). As a public company that is now using the land for development – not for liquidation – Realia should be using a valuation called Royal Institute of Chartered Surveyors (RICS) to meet IFRS rules. Slim wrote down the value of the land 80% when it
bought the company but has not re-upped the value on RICS. By changing the accounting method Realia will have to reverse provisions. There was an article in the FT’s LEX on this issue:
“Realia uses an unusual valuation system for part of its land bank that has depressed the company’s net asset value
for years. The developer has both residential and commercial properties. After Mr Slim took control of the group in
2012, Realia changed the valuation method for its residential property bank to a very conservative system used only in
Spain, known as ECO. This method undervalues its residential land by considering only liquidation value. A more
widely used method, from the UK’s Royal Institute of Chartered Surveyors, is used by all its domestic peers on their
residential land. Metrovacesa, one local rival with residential land in similar locations around the country, uses the
RICS method and has a valuation per square metre nine times higher. In fact, Realia employs RICS for its commercial
We believe that Realia is worth as much as other publicly-traded with market caps of >€1bn – note that Realia can build up to 16,000 homes, which is more than Aedas Homes with a market cap of €1.03bn. We are confident that Realia will revalue the land in accordance with IFRS standards, especially now that they are starting construction on their third housing project. Moreover, Polygon Capital with 10% of the firm, has challenged the company and has
made their disapproval public.
Details:Even though the stock is down to €0.94 from its high of €1.16, our thesis continues to play out as it shows below:
•Commercial Real Estate Segment: Realia has good office assets that have attracted new tenants, taking their
vacancy from 90% in 3Q15 to 93.8% in 3Q18. This led to higher rents, margins and NOI. We believe the office and
shopping center assets will provide significant cash flow to Realia. After the offering, Realia will also be positioned to buy additional assets.
•Residential Segment: This segment includes finished homes of inventory remaining from the 2008 financial crisis.
Realia had accelerated the sale of these homes until this last quarter. In 3Q18 there was a significant decrease in
sales, but it’s probably due to timing. I assume that this effort to sell old homes is unlikely to have a positive
value, but it will lighten up the balance sheet.
•Land Segment: This is where the hidden opportunity exists, but its also one that will take time to monetize. Realia
is one of the largest holders of residential land in Spain. Unlike homebuilders who had to absorb land from bad
loan portfolios inside the banks, Realia chose the land directly to be built back in 2000-2007. Therefore, we
believe that their land bank is valued at a very conservatively and will have tremendous long-term value.
• As stated below, Slim came into Realia and wrote off almost 80% of the value of the land bank. He has resisted
raising the value of the land portfolio because that would drive the stock. Starting in 2H17 Realia couldn’t
pretend anymore after the IPO of Neinor and Aedas proved to investors that land values and housing demand
were rising. While Slim has not increased the value of the land markedly (a metric the company shows twice a
year), it stopped going down over a year ago.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
1.Greater liquidity and expanded shareholder base: Shares in Spain include rights to limit the dilution of existing shareholders. Slim was hoping that existing shareholders wouldn’t participate in the rights offering, allowing him to win even more of the company. However, we have been encouraged by the stock’s recovery, indicating that new investors are buying stock to participate in the offering.
2.Announcement of housing projects: The only way to know that Realia has started two housing projects is by going to their website or talking to management. They didn’t disclose it in their financial report – technically two small housing projects don’t impact financials, but it’s a huge shift in the company’s strategy. They are starting a third housing project. Eventually, shareholders will reprice the company to values closer to Neinor, Aedas and Metrovacesa, three publicly-traded Spanish housing firms.
3.Change in accounting method would raise the value of the land bank: Polygon Capital is moving assertively against Realia’s improper accounting method of the land bank. If Realia doesn’t change it voluntarily, there is an avenue to report the company to the ICAC (Instituto de Contabilidad y Auditoria de Cuentas), the government’s organization to supervise that publicly-traded companies in Spain have financial that converge with financial information adopted by the European Union.