Branicks: Future Multibagger Or Bankruptcy (Incl. Trade Alert)
Branicks (BRNK) is the equivalent of MPW in our International Portfolio. It has been a disaster over the past year because it has too much leverage and the market is worried about its ability to handle its coming debt maturities.
If it fails to refinance or repay its debt, then the company will face bankruptcy and the equity will be wiped out. If that scenario is likely, then no share price is low enough as it would ultimately go down to 0.
This explains why the share price has kept steadily declining in recent months. Its debt maturities are approaching, not enough progress has been made, and its debt covenants also leave very little room for error. Negotiations with lenders are happening and the market is fearing the worst.
But the flip side of things is that if they manage to refinance and/or sell some properties to pay off near-term maturities, then the stock price could rapidly 5x from here and still be heavily discounted.
Their latest net asset value is estimated to be €21.19 per share and yet, their share price is just €2, representing a steep 90% discount. Such a valuation only makes sense if there is a high risk of bankruptcy, but if you can remove or significantly reduce that risk, then the share price should recover very significantly already in the near term.
So what are the odds?
Before we go into the update, let’s first take a step back and review how Branicks got into this situation:
A Series of Black Swans Puts Branicks On Its Knees
Before the pandemic, Branicks was one of our most successful investments. The company had managed to grow its cash flow and dividend by ~15% annually and we had nearly doubled our money at one point:
But then came the first black swan.
The pandemic hurt Branicks because it was heavily invested in office buildings back then. It stopped all transaction activity, which greatly reduced its current cash flow and also its growth rate. Remember that Branicks is not just a landlord, but also an asset manager that earns fees for managing capital for others. If there are no transactions, it won’t earn transaction fees and it also won’t be able to grow its assets under management.
This prompted Branicks to make a bold move into the industrial property sector. No one wanted to invest in offices in the post-pandemic world so Branicks needed to rapidly reinvest itself to return to growth.
It did so by acquiring a major industrial landlord/asset manager called VIB.
This acquisition was risky because it significantly increased its leverage in the near, but it could turn out to be very lucrative over the long run because it rapidly transformed Branicks from a fairly small office landlord/asset manager into a much bigger and better-diversified landlord/asset manager with primarily industrial properties.
The plan was to then sell some of the industrial properties to reduce the debt and return to growth from there.
But then came another black swan.
Inflation took off and this forced central banks to significantly increase interest rates. This came right after Branicks had taken a lot of short-term debt to close its acquisition.
Making matters even worse… a third black swan hit Branicks.
Russia invaded Ukraine, starting the biggest war on the European continent since the Second World War. This only increased inflation even further and forced central banks to keep hiking interest rates. It again stopped all transaction activity in Germany, derailing the company’s plans to sell assets to reduce debt.
Since then, Branicks has made some progress in selling assets, but not enough to address all of its near-term maturities, and this brings us to today.
Branicks has its €200 million bridge loan maturing on the 31st of July 2024 as well as its promissory notes of €225 million. There's also another €133 million of bank debt maturing this year, bringing the total to €558 million:
That's significant and they don't have nearly enough cash to pay this off as of today. As noted earlier, the plan was to sell assets to pay off some of this near-term debt, but the war in Ukraine, the high inflation, and the surge in interest rates stopped nearly all transaction activity. Moreover, the company is also very close to breaching debt covenants, which increases the risk of bankruptcy even further. Therefore, the risk of bankruptcy has become significant and the market is right to be nervous.
Even then, I continue to think that Branicks has a way out of this mess.
Just recently, they announced that they had entered into negotiations with the lenders of the bridge loan and the promissory notes to extend the maturities and to temporarily suspend some of the lending conditions.
If the lenders refuse and Branicks doesn't manage to sell enough assets or find an alternative solution, this would push the company into default later this year.
But if they accept to extend the debt, Branicks could gain the time that it needs to sell enough assets and pay off this debt.
So what's the most likely? Will they refuse or accept to extend?
While it is far from being certain, I remain optimistic that they will come to a deal because of the following 8 reasons:
Reason #1: This is mainly a temporary liquidity issue, not a solvency issue
Overall, Branicks owns great assets that are generating steadily rising cash flow and its asset management business also has more assets under management than ever before. It is not getting any transaction fees or incentives fees right now because there is no transaction activity in the German property market, but despite that, it was still able to earn $50 million of FFO in what was a very challenging year. Its rents also rose by 7% on average in the last quarter, which is very encouraging.
So in a typical year, Branicks should be able to meet all their obligations including interest payments, salaries, etc. They are earning significant positive cash flow and it is not as if Branicks was begging for more cash from its lenders. It is just that they have significant debt maturities coming their way and they don't have the cash right now due to their inability to sell enough assets in this frozen market.
Under such circumstances, the lenders should be more willing to work with the borrower because extending the loan by another 6-12 months would not materially increase the risks. Branicks is generating significant cash flow from its business and retaining all of it for deleveraging.
Therefore, it is not as if its assets were about to disappear due to large losses.
Branicks simply needs some more time to monetize assets and the lenders would get to earn additional profits if they agreed to extend the debt.
Reason #2: Branicks has made progress selling assets even despite the challenging market conditions
In their most recent announcement, they noted that they had recently sold another €60 million worth of assets, bringing the total to €285 million for 2023. This is not enough, but it still indicates to the lenders that Branicks has valuable assets, is making progress in monetizing them, and may be able to pay off its debt if given enough time.
If they managed to sell €285 million worth of assets in one of the toughest years, it probably means that they will have more success when interest rates head lower and the transaction markets recover. They sold $60 million worth of assets in December alone and there are clear signs that the market is starting to stabilize in Germany.
Reason #3: They finally suspended the dividend to retain significant cash flow for deleveraging
We have long called for a full suspension of the dividend and we blame the management and the board for taking so long to make this decision.
I understand that they were hoping to close a major asset disposition to repay the debt maturities and continue their dividend track record, but this increased risks as they were paying out significant cash flow that could have been used to partially repay the debt.
Well, hopefully, it is not too late. They finally took that difficult step and while the market hates it, it is the right move. Lenders should feel reassured to know that the company is now 100% committed to deleveraging and not paying out dividends until its maturities have been handled. It decreases risks for lenders.
Reason #4: Branicks has already paid off a large portion of its bridge loan as well as other debt, indicating to lenders that they are serious about deleveraging
Branicks has already made some progress in reducing their debt. They paid off €200 million off their bridge loan already in July last year, and they also fully repaid a €150 million bond last October.
These debt repayments show lenders that they are not just talking and making empty promises. They are making real progress in paying back their debt.
Reason #5: Lenders may be reluctant to force a default when it seems that a simple extension could potentially solve the issue
Legendary real estate investor, Barry Sternlicht, recently made an interesting remark about lenders and how they are dealing with the distress in real estate today.
He is the CEO of the private equity giant Starwood so he is constantly dealing with lenders. Here is what he said:
"We were going to give back an office building... and the bank said "well not so fast, if you want, we are going to restructure the loan... we will cut the loan in half... and you will put the money in here and we will take this as a junior note because the banks don't want the assets back. They are not set up to carry these assets. They then have to go hire someone. Do the leasing themselves. It is not their business. They would have rather have a GP hold on the assets and try to work it out.
Right now, we have an unusual situation in the real estate market because everyone is sort of looking at the yield curve and it says that rates will be lower later. Everyone says survive till 2025. Hold on to your assets and sell later." Barry Sternlicht
This seems very relevant to Branicks' situation.
Forcing a bankruptcy could mean shooting themselves in the foot since this could then lead to lengthy and expensive legal battles in court with all the other lenders and stakeholders to decide who gets what. It will then also likely lead to a liquidation of the assets, which would be very challenging in today's market. Even an expert asset manager with the right relationships and incentives is struggling so you can just imagine how complicated it would be for a lender that lacks the operational capabilities.
It could get very messy and most lenders would rather avoid such situations when possible. An easier solution would seem to be to extend the debt by another 6-12 months and demand higher interest rates and/or penalties in exchange to compensate for the additional risk. It could be a win-win for both parties.
Reason #6: Interest rates are expected to head lower later this year and this should lead to a recovery in transaction activity
Barry Sternlicht noted that: "Everyone says survive till 2025. Hold on to your assets and sell later."
That's because interest rates are expected to head lower in the near term and this should lead to a recovery in transaction activity and higher property values.
This could be what ultimately saves Branicks from bankruptcy. If the outlook was for even more rate hikes, it would be an even more complicated story. But since rates are expected to go lower in the near term, it should get easier to monetize assets in 2024.
Reason #7: There was a recent insider purchase
The Chief Operating Officer of the company bought ~$40,000 worth of stock in the open market last month when the shares traded at €3.43. Today, the share price is below €2 per share.
Moreover, throughout 2022, insiders including the CEO, the CIO, and the Vice Chairman of the supervisory board also bought more shares at materially higher levels:
In hindsight, these purchases from management and the board look just as terrible as ours. But there is some comfort in knowing that they have been buying more stock as it shows that they haven't lost hope and aslo have some skin in the game.
Reason #8: The recent change in the company name and management commentary give hope
DIC Asset was rebranded as Branicks in mid-2023. It would seem like a very poor idea to rebrand yourself right before bankruptcy. You would much rather do that during or after the bankruptcy to dissociate from the troubled past and start a new chapter. The fact that they rebranded shortly before the recent troubles might indicate that they don't expect bankruptcy.
Moreover, their commentary on their November conference call was rather positive. Here is what they said about 2024 debt maturities:
"But also for most of the other maturities in 2024, we are in negotiations with banks and investors regarding a mixture of repayment and refinancing via new debt instruments. Overall, we target to reduce our leverage through disposals in the midterm."
Then later on the call, they added that they were already in deep discussions and were preparing different options just in case they didn't manage to sell enough assets on time:
"So at the end of the day, it's disposals because it's for the goal to reduce the leverage and to bring the liquidity in. But on the other hand, we are also working on plans to refinance and to bring liquidity in other ways, and all possible ways, we can imagine so that we are secured on the liquidity side, so to say. We are in deep discussions here. And we are working on all these streams. But at the moment, I cannot say what option we take at the end of the day. But it's all about to develop options and to be prepared that we can - yes, that we have secured an option that we can finalize them."
They also felt confident that they would manage to keep covenants under control. Again, this was in November:
"The covenants of our green bond maturing in 2026 have sufficient headroom. While we see some pressure on the increased interest costs and lower fee income on our bond ICR with coverage of 2.3x, we are still comfortably above the threshold of 1.8x. According to our business plan, we expect the stabilization and turning point for this metric in 2024.
The bond LTV will also benefit from the equity release of our disposal, thereby mitigating the expected negative effect from the portfolio devaluation."
Bottom Line
Branicks has become a very speculative investment.
It has been hit by a series of black swans and it is now at the mercy of its lenders.
It could be a 0 and that is why the market is pricing it today at a 90% discount to its net asset value. If it is ultimately going to zero, then no share price is low enough.
But there's still hope... and based on my analysis, there's more hope than what's implied by the current share price.
It would seem that it would be in the best interest of the lenders to work out a solution with Branicks to give it some more time to sell assets, and if they manage to secure an extension, and then succeed in selling assets, the upside could be immense.
If over the next few years, they manage to pay off all this short-term debt, deleverage the balance sheet, and return to growth, the share price could 5-10x in the best-case scenario.
For this reason, I am making a small addition to our position with the purchase of 1,000 shares:
But I am comfortable with the idea that this investment may go to 0.
All real estate investors win some and lose some. Even the likes of Blackstone, Brookfield, and Starwood make real estate investments that end up going to zero. They have returned the keys of several properties to lenders in 2023 and that's part of real estate investing. You take risks to earn returns and sometimes the risk factors play out.
I can handle this risk because I have a high tolerance for risk, but also because the bulk of my capital is invested in safer long-term compounders like EPRT, VICI, BSR, BYG, VNA, etc. This allows me to speculate with a smaller portion of my portfolio by investing in companies like Branicks, MPW, UNIT, etc. Some of these investments work out well (TCN is a good recent example)... Others end up costing us money and in some cases, we may even face bankruptcies (CBL is an example of that).
What ultimately matters the most is the average portfolio performance, and overall, we have done quite well over time.
Sincerely,
Jussi Askola
Analyst's Disclosure: I/we have a beneficial long position in the shares of all companies held in the CORE PORTFOLIO, RETIREMENT PORTFOLIO, and INTERNATIONAL PORTFOLIO either through stock ownership, options, or other derivatives. High Yield Landlord® ('HYL') is managed by Leonberg Research, a subsidiary of Leonberg Capital. All rights are reserved. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The newsletter is impersonal and subscribers/readers should not make any investment decision without conducting their own due diligence, and consulting their financial advisor about their specific situation. The information is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The opinions expressed are those of the publisher and are subject to change without notice. We are a team of five analysts, each contributing distinct perspectives. Nonetheless, Jussi Askola, the leader of the service, is responsible for making the final investment decisions and overseeing the portfolio. We do not always agree with each other and an investment by Jussi should not be taken as an endorsement by other authors. Past performance is no guarantee of future results. Our portfolio performance data is provided by Interactive Brokers and believed to be accurate but its accuracy has not been audited and cannot be guaranteed. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated and may at times use margin and/or invest in companies that are not typically included in REIT indexes. Finally, High Yield Landlord is not a licensed securities dealer, broker, US investment adviser, or investment bank. We simply share research on the REIT sector.