FCR Immobilien AG. Profitable and with strong growth potential. Research Report. Rating: Buy (up to EUR 18.6 m) (first valuation) August 17th, 2015

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1 Research Report Profitable and with strong growth potential Rating: Buy (up to EUR 18.6 m) (first valuation) Analyst: Dr. Adam Jakubowski sc-consult GmbH, Alter Steinweg 46, Münster Please take notice of the disclaimer at the end of the document! Phone: +49 (0) Telefax: +49 (0) Internet:

2 Contents Snapshot... 3 Executive Summary... 4 SWOT analysis... 5 Profile and strategy... 6 Portfolio... 8 Market environment Figures Equity-Story Peer group valuation DCF analysis Result Conclusion Annex: Peer group data Disclaimer Contents Seite 2

3 Snapshot m EUR Basic data value indication based on peer group value indication based on DCF fair value Value indications Based in: Munich Sector: Retail properties Headcount: 7 Accounting: HGB Portfolio data Number of properties: 11 Market value: 29.9 m Euro Rentable area: 48,300 m² Net rental revenues p.a.: 3.1 m Euro Net potential rent: 3.4 m Euro Occupancy rate: 88.0 percent Ø contract term: 5,5 years Short profile FCR Immobilien has positioned itself as a holder of smaller retail properties and has been rapidly building up a suitable portfolio since Due to the focus on smaller properties away from the metropolitan regions in which investors have a strong interest, the company is acting in an attractive niche where it does not encounter much competition for the properties. Moreover, FCR strives to purchase properties mainly from exceptional situations such as insolvencies, which allows achieving above-average rental yields. This high profitability and the fast pace of growth are two crucial ingredients for an attractive equity story that could lead to an IPO next year according to corporate planning. Until then, however, we think that a significant discount compared to the listed peer group companies is justified and see the fair value of the FCR Immobilien AG currently at EUR 18.6 m. FY ends: * 2013* e Revenues (KEuro) 458 1,506 3,277 6,681 EBIT (KEuro) ,137 4,036 FFO (KEuro) Net profit (KEuro) EpS (Euro) Revenues growth 228.8% 117.6% 103.9% FFO 163.0% 37.5% -20.8% Profit growth 112.6% 53.3% 382.0% PSR PER FFO yield 1.2% 3.0% 4.2% 3.3% * Data relates to the legal predecessor FCR Immobilien & Vermögensverwaltungs GmbH & Co. KG; FFO from own calculations, key valuation figures based on the assumed value of EUR 18.6 m; Snapshot Seite 3

4 Executive Summary Focus on small retail properties: Since 2012, the company has been rapidly building up a portfolio of smaller retail properties and has by now property assets of nearly EUR 30 m. The focus is on existing properties in smaller towns that are often crucial for the supply of daily goods and are therefore not very much exposed to competition from other locations or the online trade. Purchase from exceptional situations: With regard to purchase, FCR focuses on healthy and market-proven properties that are being sold due to exceptional situations (insolvency, dissolution of an owner community etc.) on the selling side. In this way, the company is able to ensure very attractive purchase conditions. High profitability: Owing to the favourable purchase prices FCR achieves very high net rental yields, the portfolio s average is currently at 14 percent. Fast pace of growth: Since the orientation towards the current business model in 2012 FCR has increased the revenues from EUR 0.5 m to 3.3 m and achieved a post-tax return of 15 percent. Due to last year s purchases it is foreseeable for the current year as well that net rental revenues will grow by about 55 percent, even in the hypothetical case that no further properties will be purchased in Growth plans: However, an expansion of the portfolio is both more probable and already announced by the company. The management refers to a well-filled purchase pipeline and wants to acquire four further properties before the end of the year. As a larger property is scheduled to be opportunistically sold at the same time, the acquisitions will probably only make themselves felt in the rental revenues of the next year. Thanks to the high profit of the planned property sale, however, this year s result should leap ahead from EUR 0.5 m to 2.4 m. Valuations based on growth scenario: FCR intends to use the capital generated by the sale for the financing of the planned property acquisitions, so that a further expansion should be possible without the injection of fresh funds. We have based our valuations on this scenario of an exclusively internallyfinanced expansion. Nevertheless, FCR is still pursuing definite plans for the acquisition of additional borrowed capital in the form of a promissory note loan which is to be used for further growth increase. Peer group comparison and DCF analysis: In order to ascertain the company value, we compared the key figures of eleven listed real estate companies with those of FCR on the one hand, and on the other, we displayed the growth scenario in a DCF model. The result is a valuation range of EUR 16.6 m to 20.5 m which already includes a high safety discount of 33 percent. On average, we currently see the fair value of at EUR 18.6 m. Executive Summary Seite 4

5 SWOT analysis Strengths A focused business model offers a certain protection from competition and allows attractive purchase conditions Focus on properties from exceptional situations allows noticeably above-average returns The portfolio shows convincing performance figures. Management and board members with years of expertise and an extensive network allowing an early access to attractive properties Strategic risk reduction through non-recourse financing on the level of subsidiaries High and profitable growth since 2012, a sharp increase of revenues and profit is foreseeable for the current year as well Weaknesses Lack of tradability of the share Portfolio is still small, business success is still largely dependent on individual properties Low equity ratio offers only a small buffer against surprising undesirable developments Fresh capital is needed for the planned further growth The company s track record in the current business model is still short Family ties with a service provider, who carries out a small amount of caretaking activities for FCR, could lead to a conflict of interest Opportunities The market environment is currently very attractive both on the financing and the purchase side and allows a rapid expansion. In its niche, the company sees a buyer market The purchase pipeline is well filled with projects mostly nearing completion The company can cope with a considerably larger business volume with the existing structures and thus achieve economies of scale Owing to the base effect of the still small portfolio, individual purchases have significant growth effects The envisaged IPO offers additional valuation potential Threats New turbulences in the financial sector might complicate the refinancing of the bond Marked dependence on a few key persons whose expertise and network are crucial for success A noticeable interest rise would perceptibly affect the profitability of the highly leveraged business model Difficulties and delays in the acquisition of the capital needed could impede the expansion course A further rush of investors on German real estate could impair the purchase situation SWOT analysis Seite 5

6 Profile and strategy Public offering envisaged for 2016 Munich-based FCR Immobilien is a portfolio holder specializing in retail property, and especially in retail parks. The company has been active since 2012 and was converted into a stock corporation (AG) last year. FCR is managed by the founder, Mr. Falk Raudies. He is acting as sole director and holds 90 percent of the shares together with his family. The remaining 10 percent are held by a private investor who got in in the course of a capital increase in Right now, there is only a bond with a public listing, but an IPO for the share is envisaged for Focus on retail parks FCR focuses on existing retail property, especially on retail parks and smaller shopping centers. These often host companies trading in daily needs goods and therefore do not face the strong competition from online trading. In addition, due to restrictive policies towards construction permits on the part of the municipalities, such properties often enjoy de facto a local monopoly status or at least a significant protection from competition that makes it easier to achieve and maintain a high occupancy rate. and on smaller objects Another strategic guideline concerns the size of the objects, which is between EUR 1 m and 10 m. In the current portfolio, the market value is on average EUR 2.7 m, ranging between EUR 0.6 m to 8 m. FCR is thus acting in a segment that is too small at least at the moment for institutional investors and too big for most private investors and is therefore still offering attractive yields. in smaller cities The same purpose is served by the regional focus on smaller cities and towns away from metropolises. And so, five FCR properties are in cities with less than 35,000 inhabitants, in one case the number of inhabitants is even only 4,000. In such towns, the retail properties in question are often the only shopping facilities, reducing the rental risk. The combination of these criteria applies mainly to properties in Eastern and Northern Germany. Since there is a negative demographic development in many places in Eastern Germany, investors consider these markets to be difficult; however, an adequate knowledge of the specific micro situation offers as well an attractive niche. As the retail spaces are designed mainly for daily necessities, there is sufficient demand even in structurally weak areas. 18% 9% Geografic portfolio segmentention 18% 9% Source: company 19% 18% Low acquisition prices 9% Saxony-Anhalt Mecklenburg-Western Pomerania Brandenburg Thuringia, Saxony North Rhine-Westphalia Lower Saxony In order to further strengthen this strategic advantage and facilitate the achievement of above-average yields, FCR tries to concentrate the acquisitions on objects in exceptional situations, like insolvencies, unsettled successions, dissolved owner communities or closed-end funds at the end of the term. However, these exceptional situations pertain only to the seller side and not to the objects themselves. FCR takes particular care here to purchase only properties that have already stood the test in their locations and that have a sound rental situation and no discernible modernization or even renovation backlog. Nevertheless, properties with higher vacancy rates are purchased as well, provided that the sellers reward this Profile and strategy Seite 6

7 with accordingly high discounts. In these cases, FCR accepts even the higher renovation expenses that can accrue in the context of a new letting and thus of a reduction of the vacancy rate. According to the company, this purchasing strategy leads to very high discounts on the market value of the properties. For instance, FCR was able to acquire one property at 55 percent of the market value, and in two other cases had to pay only slightly more than 70 percent of the value determined by independent valuer s opinion. So far, the purchase prices in the portfolio average at 76 percent of the market value. High yields The favourable purchases enable FCR to achieve high rental yields. Based on the paid purchase prices (including incidental costs), the average net rental yield of the current portfolio is 14 percent. Only in one case the yield falls slightly short of the 12 percent mark, ranging upwards to nearly 30 percent in a property in Cottbus despite its high vacancy rate of almost 50 percent. Selective sales On principle, FCR pursues a buy-and-hold strategy and wants to expand the portfolio gradually. In order to accelerate growth, however, the company has also stated that it intends to sell about 10 percent of the portfolio per year. This would allow FCR, should the opportunity arise, to realize the high added value from favourable purchases more quickly, and thus to release fresh equity and liquidity for further growth. According to company statements, one such transaction is nearing completion; the planned sale of a large portfolio position is expected to generate an income in the low seven digit area and a significant increase of net liquidity. These would be then used for financing other purchases scheduled for the fourth quarter. Growth prepared Apart from the CEO, FCR employs currently a staff of six for the administration of the portfolio and for asset management. Thus, the structures necessary for the planned growth have already been established. With regard to the property management, on the other hand, FCR has employed a service provider to improve the apportionability of caretaker duties. The agreement with CM Center Management GmbH, with which the company is also connected by family ties, provides a yearly lump sum amounting to 3 percent of the net rental income of the respective property. Extensive network The founder and sole director Falk Raudies has decades of experience as entrepreneur and has built up and accompanied several companies over that time. From these activities stems Mr. Raudies extensive contact network, which benefits the FCR Immobilien AG in the identification and acquisition of attractive properties. Moreover, distinctive real estatespecific expertise has been pooled in the supervisory board whose members have years of experience in leading positions in other real estate companies or in the financial sector. Profile and strategy Seite 7

8 Portfolio Retail parks and consumer markets The current portfolio is being built up since By now, it comprises eleven properties with a market value of EUR 29.9 m and a rentable area of 48,300 m². Five of these properties are held by the AG itself, the rest is in possession of wholly-owned property companies. At this time, the portfolio has an average occupancy level of 88 percent. Among the portfolio properties are five retail parks, two inner-city residential and office buildings (shopping arcades) and three consumer markets. Two properties not in line with corporate strategy were sold at the end of 2014, leaving a logistics property in Oldenburg (Lower Saxony) as the only one outside of the strategic focus. However, FCR does not rule out further opportunistic purchases of properties not in line with its strategy: the logistics property is leased on a long-term basis to 3KV GmbH and generates a net rental yield of 13.1 percent. According to a statement by FCR, 3KV GmbH is a leading specialty distributor for wired and wireless IT infrastructure, security, server and storage systems. High profitability The contractual net rental income amounts currently to EUR 3.2 m, of which 27 percent are attributable to the largest property, the mall in Salzgitter. Together with the two properties next in size, the three largest objects account for around 52 percent of the net rental income, based on the potential rent their share is nearly 56 percent. In relation to the purchase value of the portfolio, the net rental income corresponds to an initial yield of 14 percent. FCR benefits here very strongly from focusing on the purchase of undervalued properties. This shows clearly in the comparison with the net yield based on the present market value of the portfolio, which is noticeably lower at 10.7 percent. The purchase prices including incidental costs average at 76 percent of the market value. net rental yield of the portfolio properties Cottbus Dortmund Regis-Breitingen Oldenburg Salzgitter Pößneck Oer-Erkenschwick Genthin Schwedt Schwerin Dessau Source: company 0% 5% 10% 15% 20% 25% 30% High occupancy rate with potential for improvements FCR s high profitability is owed not least to the currently good rental situation. Based on the relation of actual rent to potential rent the occupancy rate is currently at 88 percent. However, this figure is strongly biased by the Cottbus property that is currently generating only 53 percent of its potential rent (the already very high net initial rental yield of this property would increase ceteris paribus to 56 percent upon full occupancy). Without this outlier that is economically bearable due to the favourable purchase price, the letting rate of the portfolio amounts to a very sound figure of 91 percent which is nevertheless still offering scope for improvement and thus for a rise in profits. 100% 80% 60% 40% Source: company occupancy rate Dessau Schwerin Schwedt Genthin Oer-Erkenschwick Pößneck Salzgitter Oldenburg Regis-Breitingen Dortmund Cottbus Portfolio Seite 8

9 Good tenant structure In accordance with the focus on retail properties, the tenant structure is dominated by well-known and creditworthy trading companies, while medical practices, smaller offices and residential tenants constitute a smaller part. The biggest single tenant is the REWE Group, accountable for 12 percent of rental income as main tenant of the mall in Schwerin and in two other locations. It is followed by DIY store operator OBI and discount store Netto, each with about 7 percent. On the whole, the ten biggest tenants account for about 50 percent of the rental income; the share of tenants like REWE, Netto, KiK or Dänisches Bettenlager consists of several contracts in different locations. 49% tenant structure 3% 12% 7% 5% 4% 7% 6% REWE OBI NETTO Rossmann KiK Dänisches Bettenlager Thomas Philipps Aldi (2%) Penny (2%) mister lady (2%) Deutsche Post (1%) others 7.1 years. On the whole, almost 60 percent of the contractual letting volume is currently secure for more than five years. However, a comparatively high volume (nearly 15 percent) is pending extension or re-letting in the short term (until end of March); the main part of this is in one property only. According to company statements, however, the main tenants in this property show great willingness to extend their rental contracts, and FCR does not expect any problems with regard to subsequent letting. share of the total rent volume 60% 45% 30% 15% 0% profile of lease expiry <1 year 1 to 2 years 2 to 3 years Source: company, as of to 4 years 4 to 5 years > 5 years Source: company Long contract terms The average remaining term of the rental contracts currently at 5.5 years is also a sign of stability. The large tenants are bound even longer than that: REWE s rental contract is for 15 years, OBI is bound until 2024 (including two extension options). The ten largest tenants have still contract terms of Portfolio Seite 9

10 Market environment Attractive framework After a long period of stagnation as a result of the weak growth in the first half of the past decade and after the slump due to the financial crisis 2008/09, the German real estate market has noticeably gained momentum over the last few years. It profits from the attractive climate characterized by the combination of a sound economic growth with high employment effects on the one hand, and a historically low interest rate on the other hand. Accordingly, after an intermediate high in early summer 2011, the mortgage rates continued their long-term downward trend and reached new record lows in the last spring. By the account of the mortgage broker Interhyp, the yield of mortgage certificates, common refinancing costs for building loans, fell to 0.06 percent in mid- April for five-year maturities the lowest figure ever. After the looming rebound of the early summer gave way to a new downwards thrust, this trend seems actually to continue. Since real estate, unlike the bonds of the few safe debtors left, promise respectable profits, domestic and foreign investors have increasingly focused on German properties over the last few years. The volume of real estate transactions is a good indicator for the investors increasing interest. According to Ernst & Young (trend barometer real estate investment market Germany 2015), it has nearly quadrupled since 2009, from EUR 10.1 bn to a recent EUR 39.9 bn. A survey among 130 institutional investors carried out by Ernest & Young states that 96 percent of the respondents perceive Germany as an attractive or even very attractive location for real estate investments. Compared to the rest of Europe, the German real estate market is considered very attractive by 64 percent. Besides, the majority of the investors expect a continuing upwards trend for the current year as well that could only be curbed by the limited availability of suitable investment possibilities. billion EUR transaction volumes with German commercial properties Source: Ernst & Young Source: Interhyp Rush for German real estate Retail properties coveted According to Ernest & Young, especially retail properties are enjoying a great, and recently even growing, popularity. Although investors still name residential properties as the preferred type of use for their investments, retail properties come a close second and thus even before office properties. However, the interest is concentrating mainly on the seven metropolitan regions, only 3 percent of the respondents see their focus on other locations. The expectations with regard to price development are thus very different. While 48 and 41 percent of the investors expect rising prices for 1a and 1b locations respectively, for the properties in the peripheries this share Market environment Seite 10

11 is only 16 percent; a third is even expecting declining prices (source: Ernst & Young - trend barometer real estate investment market Germany 2015). Strong demand for retail parks However, according to real-estate service provider CRBE, the transaction volume for retail properties has been on about the same level for years, due to limited supply. Nevertheless, there is a shift towards specialist stores and retail parks within the total volume. In the first half of 2014, this kind of properties accounted already for nearly one half of the transaction volume of EUR 4.8 bn. The investors keen interest, combined with a limited supply of suitable objects, results in declining yields in the particularly coveted retail properties. According to CRBE, initial net rental yields of 4.5 percent were achieved with shopping centers in top markets in the middle of Modern retail parks could thus generate up to 5.9 percent and supermarkets 6.9 percent. Source: CRBE share of total volume investments according to asset class H shopping centers 1a retail properties Source: CRBE specialist stores/retail parks other retail Falling yields Market environment Seite 11

12 Figures Strong growth since 2012 The development of the property portfolio initiated 2012 is reflected in a very high growth of revenues and profit. In 2012, FCR or the predecessor company FCR Immobilien & Vermögensverwaltungs GmbH & Co. KG had sales of EUR 0.5 m. Last year, the sales were already at EUR 3.3 m. In the same period, the EBIT rose from EUR 0.1 m to 1.1 m and the net profit has more than doubled from EUR 0.2 m to 0.5 m. Last year s revenues include net rental income of EUR 2.0 m as well as service charge income amounting to EUR 0.7 m and revenues from the sale of properties amounting to EUR 0.6 m. Business figures 2012* 2013* 2014 Revenues 458 1,506 3,277 EBITDA ,498 EBITDA margin 44.8% 55.2% 45.7% EBIT ,137 EBIT margin 31.2% 39.2% 34.7% Pre-tax result Pre-tax margin 34.3% 24.2% 20.6% Net profit Net margin 33.0% 21.3% 15.0% In KEuro and percent; source: company; *according to annual financial statement of the legal predecessor FCR Immobilien & Vermögensverwaltungs GmbH & Co.KG Given the property-related expenses of nearly EUR 0.8 m, personnel expenses of EUR 0.3 m and depreciations of EUR 0.4 m, an EBIT of EUR 1.1 m was generated, corresponding with an EBIT margin of 34.7 percent. The financial result was EUR -0.4 m, so that deducting a partial profit transfer to silent partnership holders pre-tax earnings amounted to nearly EUR 0.7 m and after-tax profit to EUR 0.5 m. High FFO yield This development is owed to the forced purchase of further properties. Since FCR acquires only functioning properties without noteworthy modernization requirements, the new properties contribute positively to the profit immediately from the moment of ownership transfer. But the EBIT and EAT figures do not do justice to the profitability of the business model. The properties are entered into FCR s balance sheet under HGB (German Commercial Code) at amortized cost and are thus subject to scheduled depreciation, without there being any actual loss in value. Accordingly, we assume that funds from operations (FFO) which are adjusted by just these depreciations (and by the changes in provisions and the positive profit contribution from the sale of two commercial properties) should amount to about EUR 0.7 m in the last year, corresponding with a FFO yield on equity of 22.5 percent. 30% 15% 0% EBIT margin Profitability figures 2014 net margin equity return Source: company, calculation: SMC-Research Capital increase placed FFO equity return FCR finances its high growth by a combined recourse to equity and debt. Thanks to last year s profit and the capital increase carried out in December 2014, when 111,000 new shares were issued at a price of EUR 9 per share and which generated a cash inflow of EUR 1 m (gross), at the last balance sheet date the company had a group equity of EUR 3.4 m, corresponding with an equity ratio of 14 percent. Figures Seite 12

13 Corporate bond Moreover, EUR 4.5 m of borrowed funds were raised last year by means of two corporate bonds. The bonds originally planned with a volume of up to EUR 10 m have a maturity of five years and bear an interest rate of 8 percent p.a. In addition, the bondholders receive a yearly 3-percent bonus to par value, so that the costs mount up to about 11 percent p.a. One of the two bonds (of which EUR 0.5 m have been placed by the end of 2014) is listed in the Open Market in Frankfurt and secured by registered land charge and by a trustee structure program. Long fixed interest period By the end of December, the liabilities from the bond and the bank loans added up to EUR 19.3 m or 79 percent of the balance sheet total. These are set off on the assets side in particular by non-current assets in the form of investment properties amounting to EUR 21.8 m. In order to preserve matching maturities in the balance sheet and to secure the advantageous interest level, FCR is striving to finance the properties on a long-term basis. Accordingly, the current average remaining term or the fixed interest period of the property loans is 6.9 years. Including the bonds and the liabilities from former participation certificates that are planned to be partly converted into equity in the course of the next capital increase, the weighted remaining term of the loans is 6 years. The current average interest rate is at 3 percent for property loans and 5.2 percent for the total outstanding interest-bearing liabilities. The following figure shows that a large-scale refinancing is not scheduled until 2019, when the bond will mature; with regard to property loans, a refinancing of a larger volume is planned only for share of the debt volumere profile of refinancing requirements 30% 25% 20% 15% 10% 5% 0% Source: company, own calculations Non-recourse financing By making greater use of borrowed funds, FCR consistently exploits the current attractive interest rate environment and makes conscious use of a high leverage effect. In order to compensate the resulting debt risk, since last year, the properties are purchased and held exclusively by special property companies. The loans necessary for the financing of the properties are taken out and served by these companies as well, and FCR takes great care that a co-liability of the AG and a recourse to AG capital are definitely out of the question. From FCR s point of view, the risk is therefore limited to the economic equity that the AG provides to its subsidiaries and that is supplied from the AG s equity or the funds from the bond issue. A further important component of risk mitigation is the preferred cooperation with local banks from the regions where the properties being financed are located. Usually, these banks have a large information base regarding the objects, they know the local structures especially good and, in many cases, can rather well assess the creditworthiness of the tenants. In addition, local banks would probably be more willing to find a constructive solution in case of problems. A further capital increase In order to make further growth possible without straying too far from the mid-term target of a 20 percent equity ratio, FCR is currently placing a further capital increase. In this context, loans from former participation rights are to be converted to equity, but fresh funds are to be raised as well. On the whole, the equity is to increase by EUR 1 m. Accord- Figures Seite 13

14 ing to the company, this capital increase is already subscribed to a large extent. and a bonded loan planned Moreover, FCR plans to take up further borrowed capital by means of a bonded loan. This will serve, on the one hand, to prematurely replace the bond that the company thinks too highly listed by now and that is therefore not actively marketed anymore, in spite of the subscription period ending on September 30 th. On the other hand, fresh capital between EUR 9 and 10 m for the financing of the property companies equity share in further property acquisitions is to be raised. The bonded loan is to be noticeably cheaper than the bond, and the negotiations are, according to FCR, already at an advanced stage. Ambitious expansion plans Based on the planned cash inflows FCR wants to invest substantially in expanding the portfolio over the next few years and aims to hold properties amounting to about EUR 100 m by the end of Three of the four acquisitions that are scheduled for the current year are very definite and in parts nearly completely negotiated; they could increase property assets by another EUR 11 m. Moreover, FCR could manage these transactions from internal financing, provided that the planned sale of a property (that is in the final stages, according to the company) can be realized. Combined with financing effects from sales in subsequent years, FCR could be thus able to expand the portfolio to more than EUR 40 m by its own means and without further external financing. However, this scenario implies that high discounts are still possible on the purchase side, and that on the sale side prices nearing the respective market value can be obtained. Figures Seite 14

15 Equity-Story German properties hugely popular Thanks to the sound data of the German economy and the continuing record low in the interest rates, the German real estate market is very attractive from the investors point of view. Experts are of the opinion that the increase of transaction volumes that has been going on for years is only limited by bottlenecks on the supply side. Highly attractive niche In many areas of the German real estate market, the investors rush is meanwhile causing noticeably increasing prices and thus declining yields. FCR Immobilien is avoiding this development by focusing on comparatively small retail properties away from A and B locations that are too fragmented for large institutional players. Since these properties are often the most important shopping facilities for everyday needs in their locations, they offer a high occupancy safety even in structurally weak regions. Low purchase prices FCR combines the focus on a market segment with weak competition with the effort to purchase mainly properties from exceptional situations on the sale side, which often allows for an acquisition price noticeably below the market value. Such situations are for instance insolvencies or dissolutions of owner communities, FCR always taking particular care that the property itself is not a problem. With regard to the identification of and the early access to such properties, the company profits from the extensive network of its CEO and its board members and perceives this as an important competitive advantage. High yield The sum of the focus on retail properties in secondary locations and the favourable purchase conditions allows FCR to generate high net rental yields that are considerably above the usual market level. Based on the purchase price paid including acquisition expenses, the average net rental yield is currently at 14 percent. Intensive recourse to borrowed funds The portfolio s high profitability allows FCR to generate high capital yields, the equity yield was at 14.4 percent in Based on our estimates, the more meaningful FFO return on equity was probably at 22.5 percent, far above the usual market level. Aside from the high rental yield, this profitability is also owed to the intensive recourse to borrowed funds with which FCR is consistently taking advantage of the low-interest environment. This includes especially the financing of the economic equity of the property companies by means of the bonds issued by the AG. Across the group, the use of equity was thus limited to 14 percent as of the last balance sheet date. Strategic risk management In order to curb the higher risks resulting from this strong leverage, since last year FCR is consistently relying on non-recourse financing, which confines the risk of individual properties and the related credit risks to individual property companies. The preferred property financing through banks with local or regional roots serves to reduce the risk as well. Portfolio with sound key figures Furthermore, and especially with regard to risk, the careful choice of property plays an important role. As a rule, FCR buys only properties without a significant renovation or modernization backlog and makes sure that the rental situation is sound and stable. In the cases where the company is opportunistically deviating from this baseline, the management takes care to realize very favourable purchase conditions, which more than compensate the shortcomings of the rental situation. If the company can then reduce the vacancies, very high returns on the invested capital can be realized on this basis. The occupancy level of Equity-Story Seite 15

16 the portfolio is currently at 88 percent, and the average remaining term of the rental contracts as well as the tenant structure dominated by creditworthy trading companies appear sound as well. Finally, the properties high rental yields also offer a considerable buffer against unwelcome developments. High growth dynamics FCR Immobilien has grown very dynamically since the realignment to the current business model, immensely extending in a very short time both the property portfolio and the revenues it generates. Due to the first-time contribution of last year s acquisitions, a high revenue growth is already certain for the current year as well, but the company also intends to further expand the portfolio. Full pipeline According to the company, the purchase pipeline is well filled with suitable properties. In many cases the inspections and negotiations are at an advanced stage. On this basis, the management expects that three or four further properties with a total market value of EUR m can be included in the portfolio by the end of the year. Compared to the current portfolio, this would mean a growth by more than a third and thus provide a basis for considerably increasing rental income in all the more so, because the purchase course is to be forced even further in the next year, assuming that the financing plans can be carried out successfully. Profitable sale nearing completion The acquisitions scheduled for this year are to be financed with internal funds, which are expected to increase in the course of a sale of a portfolio property that is nearing completion. If this transaction can be carried out as planned, it would not only strengthen equity and liquidity, but also confirm the high profit potential of the business model. In the face of the company s still short history, this is certainly an important aspect. IPO perspective If the expansion projects on the financing and the purchase side can be carried out as planned, the FCR management thinks that the maturity to go public will be reached as soon as An IPO would decisively improve tradability of the share and thus remove a major weakness. Besides, the listing would justify and enable a higher valuation. Equity-Story Seite 16

17 Peer group valuation Considerable size differences In order to ascertain the company value of FCR Immobilien AG, in a first step we use the instrument of peer group analysis. We have set up a comparison group of eleven listed companies whose sole or primary object of business is the holding and management of commercial properties in Germany. The group includes companies of very different sizes, the market capitalization lies between just over EUR 50 m at the bottom of the scale and EUR 2.3 b belonging to the group s heavyweight Deutsche Euroshop AG, an operator of shopping centers. On average, the companies in our peer group have a market capitalization of EUR 800 m and manage real estate assets with an average market value of EUR 1.5 b. A detailed overview of the companies and their key figures are to be found in the annex. Name ISIN Market cap.* AGROB Immobilien DE Alstria Office REIT-AG DE000A0LD2U1 1,134.5 CA Immobilien AT ,652.6 DEUTSCHE EUROSHOP AG DE ,258.9 DIC ASSET AG DE000A1X3XX DO Deutsche Office AG DE000PRME FAIR VALUE REIT-AG DE000A0MW HAMBORNER REIT AG DE POLIS IMMOBILIEN DE AG VIB VERMOEGEN AG DE TLG Immobilien AG DE000A12B8Z4 1,018.2 * In m Euro, price date: High equity base In spite of the very favourable interest environment the peer companies make only a comparatively conservative use of external financing: their equity ratio averages 44.8 percent, ranging from 28.5 to 53.2 percent. Sound profitability Based on their (current) equity, our peer group companies have generated average returns of 6.5 percent last year and a dividend yield of 2.8 percent (at current prices). Here as well, the variation is great, the return on equity ranges between 0 and 15.5 percent and the dividend yield between 0 and 4.4 percent. Although there are considerable deviations between the annual profit and the FFO in the individual figures, caused particularly by the by valuation effects, the FFO-based equity return is at 6.7 percent only insignificantly above the equity return based on annual profit. Subdued profit dynamics According to analysts estimates and company forecasts, the peer companies will show only a subdued profit dynamics this year. Combined with an increase of the number of shares which is quite perceptible in many cases, the result is, on average, declining expectation for the earnings per share and the FFO per share. High valuation The investors rush on German properties that has been going on for years is now beginning to show in the valuations of real estate companies as well. Thus, six of the eleven companies in our peer group are listed above their NAV, on average (unweighted) the market capitalization of the companies shows only a 1.1 percent discount on the respective NAV. Based on PER14, the peer group is valued with 20.1, based on the profit expectations for the current year even with Based on FFO, the valuation seems slightly more moderate, the average price/ffo ratio for 2014 is at 17.4 and for 2015 at This corre- Peer group valuation Seite 17

18 sponds with an average FFO yield of 5.6 or 6.0 percent. Average peer group FCR Property assets 1, NAV Equity ratio 44.8% 14.0% Return on equity 6.5% 14.4% FFO equity return 6.7% 22.5% FFO overall return 2.7% 3.1% FFO/NAV 5.4% 7.1% Details for peer group in the annex. Absolute values in m Euro, source: company and own estimates FCR considerably more profitable Comparing the peer group s key figures with those of FCR, it is apparent that there is a marked difference in size and a much higher profitability on the part of FCR. With property assets of EUR 29.9 m and a NAV of EUR 10.9 m, the Munich-based company is considerably smaller than the smallest member of the peer group. At the same time, FCR had generated a return on equity of 14.4 percent and a FFO return on equity of 22.5 percent. In terms of equity return, FCR is thus in the top group of the analyzed companies, and with regard to FFO return on equity it shows a figure far above the peer group s top values (however, the comparison is little biased in favour of FCR, because the peer group s return on equity is in part diminished by interim capital measures). FCR owes this high equity profitability to the strong borrowed funds leverage, but this is not the only factor. With regard to FFO/total capital ratio as well, the company is with 3.1 percent above the peer group s average of 2.7 percent; the same applies for the FFO/NAV ratio where FCR s last year s value of 7.1 percent is far above the peer group. Growth scenario But FCR s figures are still considerably underestimated with regard to 2014, because large parts of the portfolio were only acquired in the course of the year and thus did not generate profit over the whole 12 months. Based on a status-quo forecast alone (a hypothetical assumption that the portfolio will be neither expanded nor reduced by sales in the current year), the net rental income would increase from EUR 2.0 m to 3.1 m. It is, however, reasonable to assume that FCR in accordance with previous announcements will further expand the portfolio in the current year as well. The core aspect of the plan presented by the company is the envisaged sale of a property that is expected to generate a high profit and a high net cash inflow. On this basis, FCR is aiming to increase the property assets by four acquisitions in the current year; according to our estimates, the market value of the portfolio after the acquisitions and the sale would amount to about EUR 34 m. Due to the late purchase and the disposal of a property the impact on the rental income remains limited; within this scenario, the company is calculating with a net rental income of EUR 3.1 m for 2015, and thus with the same figure as in the hypothetical status-quo scenario. The difference between the scenarios is in the profit, which according to company plans is expected to jump up to more than EUR 4 m for the EBIT and EUR 2.4 m on net level. This result is to be fueled mainly by the profit from the sale of a property. In comparison: last year the EBIT was at EUR 1.1 m and the net profit at EUR 0.5 m Core data growth scenario Revenues from property sale m Euro Purchase price new properties 9-10 m Euro Market value m Euro Initial net yield 13.5 % Debt ratio 20.0 % Net rent p.a m Euro Estimates 2015 Net rental revenues 3.1 m Euro EBITDA 4.6 m Euro EBIT 4.0 m Euro EBT 2.9 m Euro Net profit 2.4 m Euro FFO 0.6 m Euro NAV (per ) 14.5 m Euro Peer group valuation Seite 18

19 Owing to the profit (adjusted by the effect from the property sale) and the assumed considerable discount on the value of newly purchased properties, the NAV as per December 31 st 2015 would increase to EUR 14.5 m (current capital increase included). For the FFO, after the correction by the disposal result, we estimate a value of EUR 0.6 m, remaining slightly below last year s figures. Estimation of the fair value We use the values resulting from the growth scenario outlined above for the derivation of the fair company value. It should be noted, however, that the valueenhancing effects of the expansion that make themselves felt in the figures only from 2016 on, will not be considered here. This applies, for instance, to the impact of this year s purchases on the rental income which is only fractional in 2015 due to the late purchase but which will be full in Nor do we take into consideration the effects of the expansion continuing as planned in 2016 and beyond. With regard to the peer group companies, we use the available estimates and forecasts for FFO and EPS for 2015, while at the same time increasing the current NAV figures by 5 percent in order to simulate a 5-percent growth until the end of the year. As for the key figures, we confine ourselves to the NAV, the FFO yield and the PER15. First value indication: EUR 24.8 m The key figures relevant for the valuation that result from the compilation of peer companies are as follows: an average NAV discount of 5.3 percent, an FFO yield of 6 percent and a PER of Based on the NAV of the that we estimate at EUR 14.5 m for the end of 2015, the first figure indicates a fair value of EUR 13.8 m, while the combination of the peer group s FFO yield with the FFO of FCR suggests a company value of EUR 10.3 m. A considerably higher fair value, on the other hand, is supplied by the PER comparison, which shows a fair-value indication of EUR 50.5 m from a combination of the high valuation of the peer companies and the expected big profit jump on the part of FCR as a result of the planned property sale. The huge discrepancy between the FFO and the PER valuation is the consequence of the extraordinary income from the property sale which is not considered in the FFO calculation. On average, the comparison of the three key figures results in a preliminary fair value of EUR 24.8 m. NAV15 discount* FFO15 yield PER15 AGROB Immobilien 22.6% 9.5% 14.0 Alstria Office REIT-AG -12.3% 4.3% 19.7 CA Immobilien 26.7% 4.8% 21.2 DEUTSCHE EUROSHOP AG -15.0% 5.4% 19.3 DIC ASSET AG 32.5% 8.6% 33.8 DO Deutsche Office AG 1.4% 5.9% 19.4 FAIR VALUE REIT-AG 7.2% 6.1% 12.6 HAMBORNER REIT AG -27.5% 4.8% 43.6 POLIS IMMOBILIEN AG 29.9% 3.2% 17.9 VIB VERMOEGEN AG -6.0% 7.0% 15.6 TLG Immobilien AG -1.2% 5.7% 17.3 Average 5.3% 6.0% 21.3 In m Euro and percent; NAV values estimated per ; * neg. values mean a NAV premium Peer group valuation Seite 19

20 Criterion FCR estimate 2105 Peer group values FCR fair value indication NAV discount FFO-Yield KGV15 NAV 14.5 m 5.3% 13.8 m FFO 0.6 m 6.0% 10.3 m EAT 2.4 m m Average 24.8 m Discount 33% Fair value 16.6 m In m Euro and percent; NAV values estimated per High discount appropriate However, the value ascertained on the basis of the assumed growth scenario is, for the time being, only of an indicative nature. A valuation that is attractive from the point of view of external investors should show a marked discount, on the one hand as an incentive for subscriptions, and on the other to take account of the marked differences between FCR Immobilien and the peer companies. One of the most important differences is the lack of a stock exchange listing that is severely restricting the fungibility of FCR s share. Moreover, the considerable difference in size should be taken into consideration as well; it renders the business success exceedingly contingent on the expertise and the networks of individual persons. Furthermore, the presentable track record of FCR Immobilien is yet comparatively short, thus increasing the risk from the investors point of view. Finally, the above valuation has a severe upward bias due to an extraordinary income that remains yet to be realized. On the other hand, however, the early stage of business development offers above-average opportunities as well, such as for instance the high growth dynamics that are captured only insufficiently in the above value (i.e., only with regard to 2015). Fair value from peer group: EUR 16.6 m Considering these arguments, we think that a discount of 33 percent on the above value is appropriate. On this basis the peer group analysis delivers a fair value estimation of EUR 16.6 m for the FCR Immobilien AG. Peer group valuation Seite 20

21 DCF analysis Basis: growth scenario In addition to the peer group analysis, we have taken the growth scenario outlined above as a basis for a rough DCF analysis. This will take better account of the effects from portfolio expansion extending beyond Following the corporate planning, we thus assume in our model four further purchases for 2015, two for 2016 and one more for This is offset by one planned property sale each year. From 2018 on, to simplify matters, we have calculated with a constant portfolio and we let the rental income rise only moderately with only 1 percent p.a. In the corporate planning, the EBIT margin lies due to the profit from the sale of properties between 60.4 and 53.2 percent and we assume a stable figure of 45 percent for the subsequent period. Depreciations increase by 2017 to EUR 0.9 m and stay at this level until the end of the detailed forecast period, while simplistically investments concentrate mainly on the property acquisitions planned for the period until Subsequently, we assume continuous investment of EUR 0.5 m p.a. We assume a tax ratio of 17 percent, in accordance with corporate planning, because FCR Immobilien is exempt from trade tax due to its object of business and its structure. The following table shows the most important data of the detailed forecast period , the subsequently assumed perpetual cash-flows growth is 1 percent. Discount rate We discount the free cash flows resulting from these assumptions with WACC (Weighted Average Cost of Capital) using an interest rate on borrowed capital of 6.0 percent. We ascertain the equity cost using the CAPM (Capital Asset Pricing Model). Our risk-free interest rate is at 3.5 percent an average value of German current yield, the market risk premium of 5.4 percent is set to an average value adequate for Germany (source: Pablo Fernandez, Javier Aguirreamalloa and Luis Corres: Market risk premium used m Euro Revenues Revenues growth 13.7% 4.3% -11.3% 1.0% 1.0% 1.0% 1.0% EBIT margin 60.40% 54.47% 53.20% 47.00% 45.00% 45.00% 45.00% 45.00% EBIT Tax rate 17.00% 17.00% 17.00% 17.00% 17.00% 17.00% 17.00% 17.00% Adjusted tax payments NOPAT Depreciation & Amortisation Increase long-term. accruals Others Gross operating cash flows Increase Net Working Capital Investments in fixes assets Free cash flows DCF analysis Seite 21