Patrizia SE

SWB:PAT

Earnings Call Transcript 2019-Q3

[Operator]

[Audio Gap]

[Karim Bohn, CFO & Member of the Managing Board]

Good morning, everyone, also from my side. We would like to start the day, as Martin said, with a presentation of our results for the first 9 months of 2019. And this presentation, as I've learned, will be recorded for replay, and there will be Q&A afterwards, as always, after a earnings call. Let's go straight into the numbers. In the third quarter of 2019, we again delivered convincing results for our clients and our shareholders. We have sourced attractive real estate deals across all sectors throughout Europe. While the overall real estate market activity is still below last year's level, we were able to increase the transaction volumes we signed for our clients by 11.8% year-on-year, which, at the same time, is a material improvement compared to the first half of 2019. We do see continued structural growth in our business, driven by strong client demand in the lower for longer interest rate environment. We fully leveraged our much larger operational platform after the successful integration of TRIUVA and Rockspring and increased our assets under management by 3.8% to EUR 42.6 billion, with an increase in management fees of 10.9% to EUR 141.6 million and an increase of total service fee income by 11.5%. Operating income, with EUR 97.7 million, is basically flat compared to the same period last year, however, the quality of our earnings is much stronger. Our growth in service fee income has compensated for lower sales income from the phase-out principal investments. Let's look at the components of our operating income in a little more detail. In the first 9 months of 2019, management fees are up 10.9%, and performance fees 37.3%, both in line with guidance and both in line with our expectations. The level of performance fees, again, underline the continued and, to a certain extent, the recurring nature of the outperformance we do continue to generate for our clients. Transaction fees are still down compared to last year, but we do expect a significant catch-up during the remainder of the year, and there are 2 very positive aspects of our earnings development, I'd like to point out. First, with a full transformation of our business from a principle to a third-party investment manager, we have almost completed the disposal of all principal investments. With that, we have transformed volatile and less-predictable profits from the sale of principal investments to stable and highly recurring service fee income. Hence, our earnings quality has continued to improve, and we have fully compensated the 50% decrease of net sales revenues with service fee income. Second aspect worth pointing out: Scalability continues to work for us. Net operating income -- net operating expenses are only up 4.1% compared to the increase in total service fee income of 11.5%. We continue to grow top line revenues. Total service fee income is up 11.5% to EUR 233.7 million. Management fees are up 10.9% to EUR 141.6 million due to organic growth in assets under management and additional fees generated by the full inclusion of Rockspring. Transaction fees nearly doubled from the first half of 2019 to EUR 23.5 million, and the pipeline is well filled for the fourth quarter of 2019. Performance fees of EUR 68.6 million are partly included in revenues, with EUR 50.4 million, and partly included in income from participation, with EUR 18.3 million. Let's talk about the transaction market a little bit. As expected, our transaction volume picked up in the third quarter of 2019, and we do expect further acceleration during the remainder of this year. With our double-digit growth in both signs and closed transaction volume, we clearly outperformed the European transaction market, which is still down 7.4% year-to-date, but recovering from quarter to quarter. The outstanding transaction volume underlines the strength of our large European platform. And you're probably wondering why transaction fees are not in line with our transaction volume. And there are mainly 2 reasons, which caused the deviation. First, in the past, transaction fees were usually paid at signing, and that is now changing towards closing, which results in timing differences. For example, there are currently EUR 11 million of outstanding transaction fees based on signed deals, which will be paid later this year. Second, in particular, international funds don't pay or pay a lower transaction fee or no transaction fee but, therefore, pay a higher management fee. What it actually means is that we get the same amount of fees in equal installments of the lifetime of the funds rather than at the beginning of the inception of the fund only by the assets. And as I said, we do expect the acceleration of transaction activity to continue in the fourth quarter, with positive impacts on transaction fees. And with that, we confirm our 2019 full year guidance for transaction fees. Our performance fees of EUR 68.6 million in the first 9 months of 2019 are up 37.3%. That emphasizes our active management capabilities and investment track record, with a weighted average IRR of 10.9%. PATRIZIA expects performance fees for the entire year to range between EUR 72 million and EUR 80 million after an extraordinary strong volume of EUR 92 million in 2018. As one of the largest investment managers in Europe, we do continue to benefit from economies of scale of our large operating platform, both in terms of total cost ratio and EBITDA margin. In 2013, our total cost ratio amounted to 1.2%, and that has decreased to 47 bps today. If you look at the EBITDA margin, in the third-party investment management only, with an EBITDA margin of 8.1% in 2012, which increased to 39.2% today, and continued efficiency improvements will continue to propel our profitability and cost ratios. Our strong balance sheet in combination with ample liquidity is a significant competitive advantage, both in competing for real estate asset deals and in M&A, as it gives us the ability to act very quickly for our clients where attractive opportunities come up. And we made use of this advantage very recently to win an attractive deal before the funds or new fund was even fully established. We were right in the middle of establishing our new residential flagship funds called Living Cities when we came across a very attractive German residential portfolio. Even though most of the funds were basically raised, we were still waiting for the formal regulatory approval for the fund in Luxembourg, which is a prerequisite for the clients to actually transfer the commitments to the fund. However, with our balance sheet cash, we were able to temporarily bridge the funding and secure the deal until the formal approval was granted. Today, the total available liquidity as the end of Q3 amounted to EUR 261.2 million or EUR 547.9 million, adjusted for the bridge financing I just mentioned. Our equity ratio adjusted for the bridge portfolio remains very strong at close to 80%. We do confirm the guidance for 2019, and we expect a total service fee income of EUR 307 million to EUR 330 million, of which management fees will amount to EUR 180 million to EUR 185 million; collection fees, EUR 55 million to EUR 65 million; and performance fees of EUR 72 million to EUR 80 million. Net sales and core investments income are expected to come in at approximately EUR 30 million; and net operating expenses will come in at EUR 207 million to EUR 222 million. A transaction volume of EUR 6 billion to EUR 8 billion will translate into assets under management of EUR 44 billion to EUR 45 billion. We will continue to grow, and we will continue to grow profitably. We are a leading investment manager in the market that continues to grow structurally. Global clients are growing in size. Global clients are increasing their allocation to real estate in the lower for longer interest rate environments, and clients are consolidating the number of investment managers they work with. We have an outstanding reputation in the market globally, and we consistently produce outstanding returns for our clients. And we have a clear growth agenda and the financial means to deliver on it. I would now like to open Q&A. Thank you.

[Karim Bohn, CFO & Member of the Managing Board]

Andre?

[Andre Remke, Co]

Yes, a question on the Living Cities transaction. How could we read this? You provided a bridge financing as a usage of your available liquidity, is this a special case situation? Or would you turn back to a kind of warehousing business, as you did in the past? Or is it really a special situation here to use the financial flexibility because if you spend or exercise such transaction probably in M&A situation, you are more limited.

[Karim Bohn, CFO & Member of the Managing Board]

Yes, that's a good question. First of all, I think we never really warehoused large deals in the past. But you remember, when we did Tagus, we actually wanted to do it for clients, but given the special situations we couldn't. Now this is a very good example, where over a short period of time, and we're literally talking about a short period of time, we were able to bridge the deal based on the funding commitments we had already really for a few weeks. What we could have done, Andre, is reach out to banks and simply finance it with that. But in the interest of time and given that it was only a few weeks, we decided we do it for -- we'd temporarily bridge it and provide financing to get the deal done for our clients. So is it really limiting us in terms of M&A? Not really, because the debt markets are available to us. And if we had to bridge it, as I said, was an equity bridge in between with bank financing, it would have come cheap and available.

[Andre Remke, Co]

You mentioned the lower margin that you have on the transaction volume. Now you still have the guidance out EUR 6 billion to EUR 8 billion of signing volume. If I do the math that leaves roughly -- if I take the midpoint, roughly EUR 2.5 billion for Q4. And you also have the guidance of EUR 55 million to EUR 65 million of transaction fees. Now this would imply a huge turnaround in the transaction fees from roughly 3.7% to roughly 13 basis points. In the light of what you just explained as the reasons for the lower fee in Q3, is this still realistic? Or would you expect different volumes or just lower fees?

[Karim Bohn, CFO & Member of the Managing Board]

I think the way to think about it is not in what you cannot do, is simply take the transaction fee and apply it to the transaction volume. Because the transaction fees in terms of margin on funds where we get a transaction fee hasn't really changed. So we are -- on the deals we do, we collect the same margin, as you will. And we do have -- and that's why we're confident for the rest of the year -- we have pretty good visibility on the deals we are currently transacting on and what the fee metrics is. The reason why you cannot simply apply the transaction fee over the assets under management because there are some fees -- some funds which don't pay a transaction fee at all. And as I explained, but, therefore, we get a higher management fee. So for us, what it actually means is over the lifetime of a fund investment, the fee we collect is actually the same. The only difference is that in those international funds, we do collect the transaction fee over installments of 7 or 10 years rather than collecting it at the beginning when we acquire the assets. So economically, it's the same, but it will add more stability to the actual cash flow because it will come over a number of years.

[Andre Remke, Co]

Sorry, if I follow up here. You mentioned that foreign investors would pay rather more -- a higher management fee compared to the transaction fee. So that would basically speak towards a lower fee compared to the volume over a multiyear period coming down from 10 to, I don't know, 5 bps or whatever. Just for modeling purposes, we didn't say it doesn't make sense to keep this line flat? Or does it make sense to really model that for investors to pay less, so we do -- we have a lower fee going forward?

[Karim Bohn, CFO & Member of the Managing Board]

Not really -- well, first of all, I think you have to think about transaction fees and management fees, really as 1 recurring fee component. And with a higher transaction volume, you actually can observe we are doing. The amount of the transaction size we do for funds, which pay a transaction fee hasn't really changed. So for us, what we kept saying is that on average over the past years, we produced EUR 54 million, EUR 55 million of transaction fees every year. And what has changed since then is that we significantly expanded our investment -- our investor base outside of Europe. So that actually comes on top of the transaction volume. And you have noticed when we -- how the transaction volume has changed, how our investor base has changed and we actually had a strong German and European base, and we added international investors to the equation, and that is translating into a higher transaction volume. So in terms of modeling, I think you -- we actually feel very confident that you continue to model a strong base of transaction fees; and the funds which do not pay a transaction fee, that equates into higher recurring management fees. This is the way to think about it. This is how we model it and this is how we think about it.

[Unknown Analyst]

One question on the picking up of the transaction volume. Could you give us a flavor or an indication whether there's something special in the picking up of the transaction volume? Is there any asset class, in particular, which is being sought by the market or what about regions? Is U.K. picking up or special clients active? Maybe you could give us an indication on the background of the transactions.

[Karim Bohn, CFO & Member of the Managing Board]

Yes, I think, Anne will tell something to this later in her speech. But generally, what we observe is that deals are being done literally across Europe and across all asset classes. I would say -- the transaction volume, in particular, in retail has come down, I think, for obvious reasons. But therefore, logistics is picking up. So I wouldn't say we observe a particular trend in a specific country or asset class. And given that we are acting across Europe in all asset classes, we are basically -- our deals literally are transacting -- or are reflecting the transaction volume and the components of the European transaction volume in our transaction volume. More questions come from Zürich?

[Unknown Analyst]

Also, the management fee margin was down compared to the adjusted Q2. We knew there were some special effects in Q2 -- also down versus Q1. Could you please explain what happened?

[Karim Bohn, CFO & Member of the Managing Board]

Yes. Actually, what we keep saying is it is really -- the way to look at the fees is to look at the annual fee -- at the fees that an entire year pays. Because there are deviations from quarter-to-quarter based on booking, billing and based on how those funds pay their fees. And we look at it really -- when we budget the year, when we look at the year, we budget for the entire year, and there might be variations from quarter-to-quarter. Sometimes, you have true-ups in the fees if certain acquisition stages are reached or certain commitments in the fund. Neuhold?

[Thomas Neuhold, Head of Research of Austria]

Just a follow-up on this Living Cities transaction. Will you make any margin on this deal for warehousing it for a couple of weeks or months? Or will you pass on the assets at the cost and the demand?

[Karim Bohn, CFO & Member of the Managing Board]

Well, we do pass on -- we do pass on the assets for our clients. We warehouse -- because it's such a short period, we warehouse those assets for our clients. That's really part of the fee. If you think about it financially, such a deal actually helps us to maneuver less to avoid negative interest. Kanders?

[Georg Kanders, Investment Analyst]

As you mentioned, the negative fees. Are you already...

[Karim Bohn, CFO & Member of the Managing Board]

Interest.

[Georg Kanders, Investment Analyst]

Interest. Negative fees, sorry. Are you already paying negative interest? And how would you -- how are you working to avoid this in the future or to limit this?

[Karim Bohn, CFO & Member of the Managing Board]

Yes, we're actually paying occasionally negative interest. It is a small amount. For this year, it was below -- I think it was even below EUR 30,000 in the SDAG. The way we -- the best -- the way we avoid negative interest is, A, we have given that we have a EUR 15 billion debt business. So we have very good relationships with all the major German and European banks. And with these relationships, we are able to negotiate lines which are free of any negative interest. And the remainder is invested short term in 3- to 6-month money market funds with all investment grades, at least investment-grade banks to avoid negative interest. What's -- the only situations where we do pay negative interest is when bank lines change, and we didn't have enough time to move the money. But given the amount of money, the amount of cash we have in the balance sheet, the negative interest we pay is almost negligible. Any more questions? Otherwise, I think we can -- to answer the other questions in between, you know where to get us. Thank you very much.