Mamma mia here I go again

Posting has been quite sporadic recently due to other commitments and will continue to be over the summer months due to a project I’ve codenamed “beach”.

This write-up is about a $300m market cap, Greece heavy, London listed luxury real estate developer so if you feel like you can stop reading right here. The company is called Dolphin Capital Investors and for me it’s the second time around with the stock. I was involved back in 2012 and since then have been a spectator.

To give you a brief background Dolphin is a luxury real estate developer focusing on emerging markets (and now Greece fortunately or unfortunately classifies as one). It’s essentially like a junior mining company that goes around prospecting on a piece of land in hope of finding whatever minerals they are after, however in this case the outcome is considerably more sexy. The company’s strategy since inception in 2005 has been to acquire coastal land and develop high-end hotels and resorts with world class partners. This meant that they have acquired a large amount of land in sight in many countries for which realistically speaking they didn’t have the money to develop and the company turned into a hodgepodge of assets. I could spend pages about the history of the business but I think to an extent it is not as relevant as what’s happening at Dolphin currently.

But before we get there just a brief overview of the business. The company owns and develops projects in 6 different countries and breaks their projects into two categories: core and major projects with the first being the more advanced ones. In terms of NAV, around 80% is in Greece and Cyprus with the rest in Croatia, Turkey, Panama and the Bahamas. Below are some slides from a recent corporate presentation.

Source: Company. Note the figures are as of June 2014. For more recent, though less colourful data refer to pages 16-17 of the Q4'14 report

Dolphin published their Q4’14 update just a few days ago. NAV is currently €557m or around £68p on a per share basis (both € and £ will be used here as the company reports in € but listed in London so the share price is in £). The share price is £21.5p and is getting closer to 2012 levels. This translates into a discount of around 70%. And you might think that’s great…but why on earth should I care, it’s been cheap for a very long time. And if you glance at the below 5 year chart you are absolutely correct. Investors have been reluctant to give full credit for Dolphin’s NAV due to questions on the underlying valuation (i.e. how much of a decline in Greece is captured in the figures) and risk of higher than expected cash burn (not unheard of for a property development company). It also didn't help that on top of the ListCo there is a privately held investment manager that charged 2% on the AUM (now you understand the asset hoarding).

Source: FT

This time is (likely, maybe, potentially…hopefully) different. Let me take you back a bit to 2012. In October that year Third Point took a stake in a company via an equity raise, participating in an aggregate €50m round at a price not too different from where we are today. The macro situation in Greece hasn’t been supportive, I think we can agree on that, and I’ve also heard the same stories that you probably heard about the management of the company so we can assume that Third Point must have been getting pretty frustrated with this position. But they are still hanging in there.

I’m going to conveniently skip a few years and fast-forward to February 2015. Dolphin put out a press release where they announced plans to do the following (i) change the board of directors and add directors who either have significant real estate background or represent key shareholders, (ii) review the business plan, with focus on developing the core assets coupled with disposals, (iii) review management/investment manager compensation and (iv) less onerous governance. So far so good.

To follow up on this the company announced the following a few days ago: (i) separation of assets into core and non-core buckets with divestments on the cards, (ii) lowering the investment management fee and (iii) €75m capital raise (inc. conversion of the 2016 converts). Let’s take these in turn.

The core projects are as follows: Greece - Amanzoe, Kilada Hills and the Kea Resort; Playa Grande Club & Reserve (Dominican Republic) and Pearl Island (Panama). The company aims to develop these into resorts but further capital allocation is controlled by the board. Regarding the non-core bucket (which is basically everything else) the company plans to sell these eventually and will continue developing them to an extent to increase value. Considering the company’s 49.8% stake in Aristo (Cypriot residential real estate developer) the plan is also to sell out.

For what it’s worth, the company sees total net cash flows from the development of core projects and asset sales of €320m during 2015-19 (majority in 2018-19). In addition, they estimate €384m residual value post 2020 and €101m NAV of the undeveloped land for a total value of €805m (pre-tax basis). The company also plans to reduce gross debt from €265m in 2015 to €42m by 2019. More details starting from page 50 of the attached. Returns from core projects and proceeds from asset sales will be distributed to shareholders via buyback or dividend.

The management fee, which is currently 2% of total equity (€681m as of June 2015 – annual fee of €13.6m) will we be cut to the lower of (i) €8.5m flat fee or (ii) 1.25% of GAV from 2017 onwards. All in the board sees around €23.5m savings over five years. The performance fee has also been reworked substantially both on the returns from core assets and sale from the non-core bucket. The investment manager has been granted options totalling 6% of shares outstanding with the target share prices ranging from £35-80p for a five-year period (subject to periodical vesting and hitting performance targets). Worth noting that three board members will also spend more time on Dolphin matters so they’ll receive annual fees ranging from £150-200k and options totalling 1.25% of shares outstanding (less strict target share prices ranging from £35-50p). This is quite generous.

And last, the €75m capital raise provides the “sources” for this new strategy. The company issued 219m shares at £21p (c. 7% discount to prior closing price). As part of the capital raise Fortress, the investment manager and another investor also agreed to convert $14m of the outstanding at a lower conversion price (the remaining c. $15m holders will stay put). The overall proceeds will be used for working capital, 2015/16 opex, investment manager fees, interest and repayment of the 2016 converts. On top of the €79m funding needs the company also requires about €27m to fund the core projects, which they plan on sourcing from asset sales, JV project financing or debt (you’ll find the details on page 9 of the following document. Third Point subscribed to the capital raise and maintain their 20% holding (approx. £11m additional investment). Combined with the other investors they’ll hold around 50% of the shares, while the investment manager will own 9.7% of the shares PF for the capital raise. All in, share count increased from 640m to 905m.

Assuming all of the above doesn’t work out the board will put the continuation of the company to a shareholder vote before December 2016. If the outcome of this is a vote of no confidence, the company could be wound up, liquidated, or restructured. Thus there is additional time pressure on the management to deliver.

Coinciding with the release of the strategic review Dolphin released the 2014 results, but honestly it was a bit of a non-event amongst all the changes announced. The company generated €22m in net income (first time ever!) though mostly helped by gains on real estate revaluation. This implies around 12x P/E on a fully diluted basis.

Per the Q4’14 numbers NAV is £68p and the current share price of £21.5p for a discount close to 70%. If you make the adjustments to take into account the recent capital raise the discount closes to around 60%. And while discounts can move, perhaps it is somewhat reassuring that historical project exits took place at a money multiple of around 1.7x to cost.

Despite the positive developments and announcements the share price has gone exactly nowhere in the last few days. Perhaps the capital raise spooked people, though not sure why as the business was in need of funding if they wanted to continue development. Of course there is a small matter of execution as well.

Not even sure where to begin with the risk factors: Greece, largely illiquid land investments, so-so track record, asset hoarding and really I could go on. However, with the changes around the board, governance, strategy, compensation etc there might be something here warranting a closer look. I see this idea essentially as a deep value, long-term option on the recovery of Greece and improvement in the company's strategy and execution.

If you prefer to see what these guys do there is a short documentary on YouTube. It’s worth a watch, some of their stuff is really sexy. Oh yes and in closing, the company posts broker reports on their website. Read those with a pinch of salt.

On the Orient Express

When it comes to trophy assets few companies do it like Belmond. It owns hotels such as the Cipriani in Venice, Grand Hotel in St Petersburg, 21 Club in New York and operates the fabled Venice Simplon Orient Express train, amongst others. Now combine this collection of assets with an awkward shareholder structure and you have an interesting situation on your hand.

Source: Belmond

The company (originally Orient Express Hotels) was founded in the late 1970s with the acquisition of the Hotel Cipriani followed by the Orient Express. OEH was housed under a shipping company called Sea Containers founded by James Sherwood, which later filed for Chapter 11 and was forced to spin off OEH. Over the last few years the company hasn't been managed in the best possible way and there was a lot of shareholder discontent, while the liabilities side of the balance sheet began to baloon. To bring the story to the current years, the CEO resigned in 2011 for personal reasons and the board began a search for a new one. In 2012 it hired John Scott, which also marked the beginning of a turnaround of the company (profile on him in Fortune). He has a good track record in the hotel business and previously was the CEO of Rosewood Hotels, which he turned around then sold to a company belonging to HK’s New World group.

He began to restructure OEH's operations, initiate $50-70m asset sales and seek out management contracts. His team also began a rebranding effort to move away from OEH to Belmond. Apparently, most people thought that what OEH does is operate old trains between London and Venice only. With the new branding they can consolidate hotels and use it to cross sell customers. In addition, by establishing themselves as a strong hotel operator they can position the company better for management contracts. In short, the new team aims to rid the business of non-core assets, reinvest in what’s core and pay down debt. The company entered the recession with a lot of leverage (at some point over 9x EBITDA) while currently it's at a more manageable (though still high) 4x. In addition, a new board was also brought in (more on this and governance below).

All of the above was reflected in the share price which has steadily climbed from around $11 to over $15 but then 2014 came and things started to go wrong in a few markets, such as the exposure to Russia (the St Petersburg hotel is about 10% of keys) and the share price started to tumble to the $11 levels.

It’s worth noting two things here: (i) these sort of assets attract a lot of attention from suitors and (ii) an odd governance structure.

In 2007/2008 Indian Hotels (publically traded leisure arm of Tata) tried to make a run for the company when it owned over 11%. It did the same in 2012 when it had a 7% stake (you can read a good summary here from the Economist). In 2013 the bid was ultimately rejected by the board on low valuation but Indian Hotels still owns that stake. In addition to Indian Hotels, the Reuben Brothers (UK based investors, mostly involved in real estate) also own a 6% stake in Belmond. Back in pre-recession times there were rumours that they were looking to buy the company (at a $3bn valuation!).

Recently I re-read Peter Lynch’s classic “One Upon Wall Street” and he talked about trophy assets. At some point in his career he came across a company trading OTC that owned Pebble Beach with a $25m market cap. He didn’t buy the stock but Twentieth Century Fox did buy the whole company for $70m a few years later. They eventually sold assets off, starting with one piece of land that was alone worth $30m i.e. there was substantial underlying value but it needed a catalyst.

Apart from better operational performance a key catalyst would be getting rid of the current governance structure. Basically, there are class A and B shares. While it’s generally not such a big deal in this case the B shares don’t trade, instead are held by a subsidiary of the company, which also happen to carry a 10x vote vs class A shares, essentially giving control to the board / company (this is a legacy setup by the previous owner). While it enables mgmt. to act for the long term (assuming the incentives are aligned) it also makes people jittery given missteps from the old guard.

Now, what is it worth? Current market cap is $1.2bn and $1.7bn EV trading around 15x current and 14x forward EBITDA vs historical avg of 16.5x. Current EBITDA is estimated to be around $110m and mgmt. guides for $18-32m to be added by 2017 (vs 2014) from renovations / additions, increase in mgmt. fees, cross visitation etc on top of organic growth. Taking this at midpoint (and assuming no organic growth) indicates $8m increment p.a. so Belmond could be around $135m by 2017 (implied share price of $17, assuming historical multiples).

Based on the historical multiples for the various segments, the market implies around $700k/key valuation for the owned hotels. Now assuming the valuation would get back to pre-crash levels ($800-900k/key) it would imply $14-17 per share. Global trophy hotel asset transactions have been pushing $1,000k/key recently; assuming this for a second would imply valuation of $19/share. The two M&A attempts were made at average EV/EBITDA of 18-19x. Applying this on 2017 earnings gets you to similar valuation. Looking at an absolute downside, Belmond has traded at book before when things looked really bleak, which would imply $8/share.

While it appears that there is value in Belmond, keep in mind that history shows a lot examples of investors falling in love with trophy asset hoping for a greater fool, only to find their hands burnt in the process. However, I think that mgmt. has every incentive to carry on with their plan and so far they’ve made rational decisions, which (as noted above) were reflected in the share price before all the events around Russia etc kicked in.

The two key catalysts for getting to the above valuation ranges are (i) mgmt. delivering on their plan and (ii) board doing away with the shareholder structure (for those wishing for some kind of activist involvement…there is no chance). Also for the same reason M&A is unlikely for now (unless they get a $30/share offer tomorrow).

Having said all the above about the shareholder structure I do think there is hope. I’d urge you to listen to the company’s November 2014 investor day (or read the transcripts) where the topic of the shareholder structure has been debated to death. The CEO noted that this is being discussed in board meetings but actual progress has been slow to date. Let’s see. If the board would eliminate this the valuation uplift would be accelerated for sure.