Gokul Raj Ponnuraj of Bavaria Industries Group presented his investment thesis on Patrizia SE (Germany: PAT1) at European Investing Summit 2022.
Thesis summary:
Patrizia SE is a top-three European real estate asset manager with a strong balance sheet (25%+ of market cap as net cash). The shares recently traded at 0.35% of AUM and 0.7x book value, despite having an owner-operator who has compounded book value per share at 15.5% over the past decade.
Patrizia has transformed from being a capital heavy real estate operator into an asset light investment manager with 56 billion euros of AUM. It is now a scaled-up platform as the firm has grown AUM at 24% CAGR (including inorganic) over the last decade. Over 80% of their AUM is in perpetual or 10 year+ vehicles and that provides strong resiliency to the business through a predictable management fee stream.
Patrizia has a conservative culture anchored by 54% ownership by the founder. Over 80% of the real funds are in the Core & Core+ categories compared with just 20% in the higher risk value-add segment. They do not accrue carry income to the financial statements until realized except in special-purpose vehicles where IFRS forces them to. The leverage on their properties is also lower than that of peers, with an average of 35% LTV.
The long-term performance of their funds is healthy with 4.2% outperformance versus the benchmark. The valuation marks are conservative as they have always used a long run average discounting rate even when interest rates fell below zero. The unaccounted carry provides buffer to the current valuations.
In a normal year, transactions are 10-15% of AUM and that provides Patrizia with lucrative fee income along with an ability to book carry income. With the current market uncertainty, I believe that the transaction and performance fee streams should be weak for the next few quarters. Management expects to get to 250 million of management fees yearly in the medium term and that should provide strong stability to profitability.
The firm does not need any capital for growth, and Gokul Raj expects strong dividend payouts going forward. On incremental AUM, the firm will be able to earn almost 20 bps per year, and thus if the firm is able to grow the AUM to 80 billion as the management wishes, strong growth in operating profits appears likely. Once the bearish sentiment around Europe turns around, Patrizia’s shareholder returns should come from all three levers – revenue growth, margin expansion and valuation re-rating.
The market cap of Patrizia is around 900 million euros. Net cash on the balance sheet is around 250 million euros. Their co-investment portfolio is worth 550 million euros. The majority of this is linked to Dawonia which is a solid Munich residential real estate portfolio that is marked at a 3%+ rental yield. With increasing cost of construction and undersupply in Munich, there should not be a big markdown in this value.
Hence, the asset management business, with 56 billion of AUM, is available at a paltry 200 million euro valuation (35 bps of AUM), several times cheaper than private market transactions in the alternate asset management space. On traditional metrics, P/B is 0.7x, tangible P/B is 1.2x, EV/ EBITDA is 6x, and the dividend yield is 3%. While we await markets to value them as an alternate asset manager, there is strong downside protection due to the assets. Thus, the risk-reward is asymmetric for an investor at the recent price.
Catalyst. Dawonia portfolio sell-down at recent market value could release 500 million euros of capital, leading to net cash on balance sheet rising to ~80+% of the recent market cap. The end date for the portfolio is 2023 but could be extended if market conditions are not favorable.
Risks. There will be headwinds in transaction and performance fees along, with potential markdowns in the co-investment portfolio. In the long term, the company needs to fix its cost structure and demonstrate operating leverage to get a high valuation. The cost-to-income ratio is still elevated despite scale. The management has slightly overpaid for inorganic growth in the past. They may be spreading themselves thin with expansion into newer asset categories and geographies. The firm should attract strong investment talent to be successful, and their conservative culture might prove to be a deterrent.
Listen to this session:
slide presentation audio recording
About the instructor:
Gokul Raj Ponnuraj is a value investor with a focus on small and mid-cap compounders and spin-off’s with a bias towards emerging markets. He has been investing in the Indian markets since 2006 and in global markets since 2017. Gokul Raj manages the public equities portfolio at Bavaria Industries Group. The firm uses its balance sheet assets (permanent capital) to invest in opportunities with an attractive risk-reward trade off. Gokul Raj holds a Master in Finance degree from London Business School and a CFA charterholder.
