Clearance Capital Issues an Open Letter to Kungsleden AB shareholders highlighting an alternative to the Proposed Rights Issue announced on 2 Feb 2017
Dear Fellow Kungsleden AB Shareholders;
As the representative of shareholders owning 1.6% of Kungsleden AB (“Kungsleden” or “the Company”), we have privately urged Kungsleden management and the Board of Directors to reconsider their decision to proceed with the Proposed Rights Issue and rather continue with the work that has already transformed the company as an investment proposition. We have conveyed our assessment that the Proposed Rights Issue is value destructive and not in the best interest of the shareholders. We believe it is necessary to open the dialogue to all shareholders.
Kungsleden shareholders have endured a difficult time over the last 3 years. The net asset value (”NAV”) performance of the Company has yet to live up to the strategic refocusing at the portfolio level. Since the appointment of Ms Pehrsson as Chief Executive in September 2013, the growth in NAV per share, adjusted for items which have eroded value not attributable to the current management team (legacy tax claims and the 2014 dilutive rights issue) has not kept up with that of the Company’s peers. The share price has followed suit.
Cumulative total company return(1)
| Since Sep 2013 | 3 year return | 2 year return | 12 month return | |
| Kungsleden | 25.4% | 22.6% | 21.8% | 23.3% |
| Kungsleden – adj(2) | 54.4% | 51.0% | 29.7% | 18.1% |
| Castellum | 81.2% | 77.2% | 57.0% | 36.2% |
| Fabege | 94.3% | 92.2% | 64.4% | 40.5% |
| Hemfosa | Not listed | 104.1%(3) | 80.7% | 32.4% |
| Hufvudstaden | 69.9% | 60.6% | 42.4% | 19.4% |
| Klovern | 138.6% | 117.1% | 52.1% | 29.2% |
| Wihlborgs | 95.8% | 90.7% | 62.6% | 28.9% |
(1) Total EPRA net asset value return (including 50% of deferred tax provisions) plus dividends. Source: Clearance Capital calculations
(2) Kungsleden, adjusted for legacy tax provisions and the 2014 rights issue. Source: Clearance Capital calculations
(3) Since listing 21 March 2014
Cumulative total shareholder return to 2 February 2017(4)
| Since Sep 2013 | 3 year return | 2 year return | 12 month return | |
| Kungsleden | 46.0% | 39.2% | -8.4% | 5.7% |
| Castellum | 72.3% | 51.8% | 14.6% | 15.5% |
| Fabege | 138.1% | 102.6% | 38.2% | 19.0% |
| Hemfosa | Not listed | 101.6%(5) | 0.0% | 9.9% |
| Hufvudstaden | 84.7% | 75.0% | 34.4% | 22.5% |
| Klovern | 108.7% | 76.0% | 9.4% | 6.6% |
| Wihlborgs | 77.8% | 56.5% | 7.3% | 6.1% |
(4) Total share price return with dividends reinvested. Source: SNL
(5) Since listing 21 March 2014
Transformed business
Under the leadership of the current management team, the Company has implemented a transformation plan, which underpinned our decision to invest in Kungsleden. The progress achieved to date has been significant. The highlights of this transformation includes:
- Reducing the number of municipalities from over 140 to circa 50;
- Increasing portfolio concentration to metropolitan areas from 28% to 61% (78% including Västeras);
- Introducing and growing the cluster strategy to the current 63% exposure;
- Improving the financial viability of the Company by reducing the average cost of debt by nearly 300 basis points;
- Disposing of the non-core Nordic Modular business; and
- Being a net seller of real estate in 2016.
As the reduction in the Company’s risk profile becomes clear to investors, we believe the share price should re-rate, closing the discount to the Company’s NAV, to reflect a marked decrease in the cost of capital. We believe this rerating was well underway, but will be derailed by this poorly timed capital increase.
The objectives of the Proposed Rights Issue, as highlighted in the announcement, are:
- Reducing financial leverage;
- Value creating investments in the existing portfolio; and
- Adding assets to subscale clusters.
Whilst every phase of the capital cycle brings opportunity, we find it difficult to make sense of the apparent inconsistency between the management team’s implicit assessment of the state of the direct real estate market, as it informs their view of the ideal level of leverage, and their compulsion to acquire new assets. Our assessment is that the investment market in Sweden is very strong in a historical context, with yields at record lows. As such, we agree that caution is warranted, as investors in this market exhibit risky behavior in the search for high-quality income.
Alternative to the Proposed Rights Issue
At the date of the Proposed Rights Issue announcement, the share price implied a circa 19% discount to the last reported net asset value (circa 8% gross asset value discount). It is this discount that should compel the Board of Directors and management team to achieve the objectives of reducing leverage and funding value-enhancing capital expenditure in the existing portfolio from the Company’s existing resources. The Board should encourage the management team to expand the SEK0.9 billion disposal program of non-strategic properties earmarked for the rest of 2017 to SEK2.1 billion.
Based on our estimates, when the net proceeds from these increased disposals, together with the disposals announced on 28 February 2017, are combined with the free cash flow generated annually from the existing portfolio, the Company should be able to achieve its stated target leverage levels (bottom end of the 50-55% range). We accept that a degree of earnings dilution would be unavoidable. However, the improvement in the quality of earnings and the reduced balance sheet risk will lead to a significant reduction in the Company’s cost of capital, which should lead to a share price more reflective of the portfolio’s fair value.
To conclude, we do not think it is wise to place ready capital at the disposal of the management team now, given the dilutive impact of the Proposed Rights Issue and the Company’s underperformance relative to its peers. We believe that the strategy to optimise the portfolio via the continual fine-tuning of the real estate offers the best way to build long term risk-adjusted shareholder returns. We agree with management’s view on lower leverage, however we find the cost of reaching that goal by way of a capital raising at a deep discount to net asset value too costly. We intend to vote against the Proposed Rights Issue Resolutions at the upcoming Extraordinary General Meeting. We urge fellow Kungsleden Shareholders to follow suit.
Jacques Van der Merwe
Director and Senior Portfolio Manager
Clearance Capital Limited
About Clearance Capital Limited:
Clearance Capital Limited is a London based, FCA authorised and regulated investment management firm that invests in European publicly traded real estate securities.
| Contact details: | 26 Throgmorton Street, London, EC2N 2AN |
| +44 203 002 7685 |
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