Of (in)elegance and (un)fairness

Below is a summary of our publication of December 18, 2024 ("of elegance and fairness").

Our conclusion is that Vonovia's offer for the minority interests in Deutsche Wohnen is not fair.

We recommend voting against the Domination Agreement at the January 2025 AGM.

There are a few weeks remaining to determine if and how active minority shareholders might formally challenge this operation, potentially leading to a significant improvement in the offer.

Summary: We reviewed the evaluation report (“Contract Report”) and the independent expert’s opinion on Vonovia’s proposed Domination Agreement terms. Both documents conclude that Vonovia’s 2021-22 investment of €18.3bn at €53 per share is now valued at €8.2bn (approximately €25 per share). These reports highlight inconsistencies, reinforcing our belief that the offer’s parameters rely on valuation methods that do not accurately reflect the asset’s true value. DW minorities get a raw deal. 

Vonovia’s reliance on the expert’s conclusions for its offer on Deutsche Wohnen leads to some unusual conclusions. If Deutsche Wohnen is valued at €9.7bn, significantly less than its NAV of €16.6bn, the DW assets consolidated by Vonovia are overestimated by €6bn. This raises questions about the need for a significant write-off by Vonovia or the future accuracy of its accounts.

The expert values Vonovia at €25bn, while its NAV was €36.7bn in Q3 24, a difference of €11.7bn. After accounting for the €6bn loss on Deutsche Wohnen, Vonovia would need an additional €5.7bn in depreciation on its other assets for consistency. This suggests that properties in Leipzig, Dresden, Hanover, Kiel, or Westphalia at Vonovia would be valued higher per sqm than those in Berlin at DW.

If Vonovia implies that Deutsche Wohnen and its assets are worth €11.7bn less than their book value, lenders might question the value of their bonds or loans, including covenants. This reasoning highlights the overall inconsistency of the valuation scheme, including its conclusion regarding DW’s minority shareholders.

It is uncommon for shareholders and analysts to have 10-year Business Plans. Vonovia provided these to the valuer, offering insights into both companies. The independent expert did not challenge Vonovia’s BP, basing his analysis on the buyer’s reality.

Deutsche Wohnen’s rental revenue is expected to grow by 3.9% CAGR over the next decade. Vonovia ex-DW’s build-to-hold strategy may be more capitalintensive, posing a specific risk as its future cash flow partly depends on recycling cash from apartment sales. While we refrain from further DCF analysis, here are some observations on Vonovia’s Business Plan:

- The expert applies the same discount rate to rental and Residential Development activities. Residential Development is riskier, leading to a relative overvaluation of Vonovia.

- Expected profits from Residential Development will increase tenfold over the next decade, with 14% margins by 2034. The necessary working capital or capex for this growth is unclear. The EBITDA calculation base inflates Vonovia’s valuation, especially the terminal flow.

- Vonovia’s valuation heavily relies on a terminal flow in 2034, resembling a real estate cycle peak. Anticipating stability at this level is unreasonable. In 2024, non-rental activities will generate €271m EBITDA, rising to €916m in 2034, discounted infinitely.

- If Vonovia had used the expert’s method in 2021, it would not have paid €53 per DW unit, implying a €10bn savings over three years.

- Valuing DW at €24 suggests Vonovia’s management considers its own current €30 valuation reasonable.

Within the expert’s framework, we see a risk of overvaluing Vonovia based on the parameters used. 

Regarding Deutsche Wohnen’s Business Plan:

- Comparing Deutsche Wohnen to consolidated Vonovia partly compares DW to itself, given DW’s significant weight in Vonovia’s assets. A more coherent approach would consider Vonovia ex-DW and DW separately, aligning with market perceptions.

- Vonovia ex-DW’s higher leverage is not considered, overlooking its higher overall risk compared to DW. This alone justifies a discount rate differential favouring DW.

- If Vonovia were to pay €1.22 per share for 400m DW shares, the €488m annual payment exceeds the €250m distributive capacity indicated by Vonovia for 2025. Vonovia shareholders might question paying minorities double the distributive capacity.

- The undiscounted terminal value relative to expected rents or EBITDA in 2034 seems low.

Within the expert’s framework, we see a risk of undervaluing DW based on the parameters used.

Since 2021, activist Elliott has held a long position of approximately 3% in DW, with shares acquired around €50. This initial investment of approximately €600m is now valued at approximately €300m. Since 18 September 2024, Elliott appears to have established a short mirror position of 1.2% in Vonovia, valued at approximately €260m. Considering a pair trade partially supported by Vonovia’s proposed exchange parity, it may be in Elliott’s interest to seek a revaluation of its long position, potentially incurring some (small) legal fees to challenge the deal in court. There remains a very simple possibility: that Elliott has simply prepared its full exit. We will know very soon.