Vukile Property Fund Limited (VKE) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to our presentation this afternoon. I'd like to thank everybody for taking the time to join us. And at the same time, also apologize for the delay between when the announcement came out last week and the presentation today. But it was Jewish New Year. And for religious reasons, I wasn't available. So thank you for bearing with us and dialing in for the presentation today. Just before we get into it, if anybody would like to have a one-on-one meeting set up, very happy to make myself available. Please reach out to Marijke, whose details are on all the press releases and also on our website. As regards to the presentation, if you have any questions, please type them into the question box, and we'll deal with them at the end of the presentation. So really, what we wanted to do today is really just have a discussion around the decision that we made to exit Lar Espana, to provide context for the decision why we made that. And I suppose most importantly, to discuss what this means for our business going forward and how we plan on utilizing that money. So really, to start off, just to set the scene, let's start off with the solid investment case that we had in Lar, and that really is captured in the slide, which is excerpts from the Board strategy pack that we put together, the Board pack in November 2021. And that was sort of motivating the deal to our board and setting out the strategic rationale for why we felt this would be a good idea. So in the first instance, Lar Espana, obviously is a business that is very much almost identical to Castellana, operating with very similar assets in a market that we obviously know and understand exceptionally well. The key difference being that they had the external management company, which is always a concern for us, but you'll understand how we sort of felt we could work with that going forward. And also the flexible debt capital structure that they had where they had recently done two green bonds at some very attractive sources of funding. So a business that we felt we understood, we could easily get our arms around the issues and the metrics in the business and made a tremendous amount of sense. Pricing was really a very key attraction to us, really coming in at around a 50% discount to NAV at the time of the investment. Those pricing levels were not available in the direct market. And certainly, when you then consider the further benefits of the quality of the assets and the diversification, so really getting access to our whole portfolio at a deep discount was very attractive. By taking a stake in the company, it really offered Vukile and Castellana, the optionality to create a large, dominant, more liquid retail real estate SOCIMI in Spain. And I think we've often felt that scale is an important driver in terms of attracting capital. I think Lar was off the radar screen of all investors in the market. And we always felt that if we were to have a stake, the optionality of creating a bigger vehicle would always be something that could add value. Now that's a very important point to keep in mind. We're going to get back to that going forward as we sort of look to the future. The transaction also was, I think, very well timed. Obviously, retail had been very negatively impacted in the prior 3-year period. I think there was a very negative sentiment towards retail overall. We always felt that was very misplaced. And in fact, even today, we feel that whilst it's improving, it still is maybe a little bit more negative than it should be. We are very bullish about the prospects for retail, and I think that's creating great buying opportunities. And then obviously, coming out of the COVID-19 pandemic, where retail really was just the last thing anybody wanted to talk about. So that resulted really in the business being excessively punished in our view, in terms of share prices. And then probably the most important point is the following: That there is very positive data emerging from the Castellana portfolio in late 2021, which indicated to us that we were at the onset of recovery, and that is something the market wasn't seeing. So when you put that all together, we felt the timing was absolutely ideal to move forward. So to summarize, really, number one, Vukile was ideally positioned to underwrite the deal given the high similarity between Castellana and Lar Espana. We saw a very attractive pricing entry into the market and especially so when considered relative to direct assets. The market was certainly ignoring retail and was overlooking the improvement in certain value drivers within Lar Espana. So the management fee had been renegotiated. That is bringing back additional money into earnings. The market was not really taking consideration of that. Also, the cost of finance dropping to around 1.8%. The market didn't really pick up on that either. There was also an improvement in the alignment of interest between the external Manco and the shareholders. And I don't say that as a praise that we like the external Manco structure. What it did mean is that Grupo Lar now had a much bigger stake in the company and had more financial interest in the outcome of the company versus the management agreement which was the situation prior to that restructuring. And therefore, we felt that there would always be better outcomes. If we're sitting alongside them as co-shareholders because they had a greater financial interest. So that was also an important driver for us. And then we always felt that there was potential to unlock significant value through capital growth. And there were multiple options that we have sort of listed at the time. Obviously, there was an idea of potentially merging the businesses. There was a question of whether we could take over the business. The question of whether we would swap our shares for assets, effectively buying the assets at a deep discount or whether there would, in fact, be a takeover by a third party in due course. And all of those are identified as potential outcomes at the time of taking or making the investment. And therefore, to reiterate, we felt that there was a very significant capital growth potential. And whilst we are evaluating these various options and seeing how they will play out, we're being paid a very attractive dividend throughout. So with that, having set the scene as to why we made the investment, let's move forward now to sort of how we evaluated the proposals in order to derive the best outcome for our shareholders. So the initial offer made by the consortium of Hines and Grupo Lar was at EUR 8.10 a share. And obviously, we sat down and strategically reviewed all of our options to decide the best way to move forward. And there are, I guess, five prism through which we evaluate the proposals. Number one was the financial metrics, focusing on the impact at a Vukile level of where we're going. And we found that a lot of the measures we're looking at there were, in fact, negative in that it will be dilutive to us based on the price we felt we would need to pay relative to our cost of capital in order to raise the money to get that done. We looked at the impact on the share price, assuming we'll have to take on more debt to get the transaction done. And I would say probably the most important piece of data was the yield analysis. So when we looked at what we thought we would need to take the price to in order to be successful, the yield on the assets, in fact, was then looking very similar to other direct opportunities in the market. And we felt that we could pursue those opportunities at a much lower deal execution risk than actually having to go ahead with a counter bid. So that was one of the prisms, was the financial metrics. The next issue was deal execution risk in terms of launching a counterbid. And there are a number of issues there. Number one is the cost of launching the bid, which was very high, in terms of advisory fees, putting in additional funding, et cetera. Then there is a sealed bid process. And without getting into too much detail, even if we put in a higher bid, it would never be a guarantee that we would then win that because there's an opportunity then for the original bidder to come in with -- at the sealed bid process. So in other words, getting into a bidding process was never guaranteed to end up being successful overall. So that was certainly a concern that we had. So really, when you looked at it, there was an uncertain outcome that came with a high cost of execution and no guaranteed route to where we would get the price. And when we compare that to the value we'll get relative to our cost of capital, we felt that, that didn't make too much sense. From a strategic perspective, as I mentioned earlier, we felt that there is a strategic benefit of scale. So a question we had to debate was by walking away from a counterbid and buying Lar Espana, do we give up on our strategic rationale of scale. And I think the answer is we feel very confident that we don't do that because we feel that there is a very clear path from where we are today to getting to approximately ZAR 1.6 billion, ZAR 1.7 billion of assets in the Iberian Peninsula by the end of December 2024. So that already takes into account the initial Portuguese deal, Portuguese assets that we announced last week, those three shopping centers. It's assuming we take the proceeds from law and redeploy those into an asset, and we are already looking at something in quite a lot of detail on that front. And there are a few other assets that we have currently in the pipeline. So we feel that if we sort of get to the end of the year, at approximately ZAR 1.6 billion, ZAR 1.7 billion of assets, we will certainly have met all of our objectives in terms of scale and that Castellana becomes a tremendous launchpad for further growth in Spain and Portugal and perhaps elsewhere in Europe. So bottom line is we didn't feel that the strategic objectives we've set ourselves would be compromised at all. We also felt we needed to take into account the positioning with the South African investor base. Obviously, that is our source of capital where most of our shareholders come from. And it seemed that there was a strong preference from our investor base for us to take the cash. I think all around being seen as a great investment of how we saw the opportunity in Lar, we'd ridden it, and if you are saying well done and perhaps take the cash. So there were views informally being shared with us from some of our investors. I think what it does do by being able to crystallize this deal, it cements our position as a trusted allocation of capital. And you'll see the returns on the next slide how high they've been. And that means that we can keep coming back to the market when we see opportunities that we feel are attractive, exciting and off the back of the solid track record and others that we will be able to get support for future deal flow. And importantly, as we always say at Vukile, we deliver on what we say we would do. And I think this is a great example of how we've put that together. And then finally, we also had to evaluate what does this do to our positioning in Europe. And I think on one hand, doing the deal concluding that would have sort of been a very bold statement of "we have arrived". We're a key player in the European property markets. But I think when we look at it, we already have a very good and strong relationship with key advisers, key bankers, brokers. There's very little in the deal environment that doesn't cross our desk. And we felt that, in fact, we are very well positioned already in that space and having around ZAR 1.7 billion where we anticipate finishing the calendar year, I think, does make us sort of an important player, certainly in the Iberian retail landscape, but I think more broadly in Western Europe as well. And as we often joke, if we have EUR 200 million of cash, it's unbelievable how popular you become. So all in sudden, we are fighting us for opportunities, and we're seeing very good relationships and deal ideas coming out of the current situation. So whilst it would have been very tempting to do the deal, we had to make sure we would do the deal for all the right reasons and not let ourselves get driven by ego or deal excitement. So when we looked at that and we concluded we could gain a lot reputationally if we did the deal but we certainly wouldn't lose reputation if we didn't do the deal. So those are the five key parameters that we are working with and evaluating our proposals. That led us to then start negotiations. And we were able to increase the offer price from EUR 8.10 per share to EUR 8.30 per share. Obviously, that's for all shareholders. So all shareholders in Lar Espana benefit from the negotiations we did. And we felt at that level, it therefore made sense for us to not put in a counterbid and rather to take the offer. So we do know that certain people in the market were anticipating a counterbid, I think I've explained why we decided that wouldn't be the best way for us to go. But that the best value and outcome for our shareholders would be derived from accepting the deal and redeploying that capital into other existing opportunities in Spain and Portugal which are already sort of on the table and being evaluated. So based on the improved offer price, we've concluded the irrevocable. We'll be tendering our shares just over 24 million shares. And we'll receive in round numbers, EUR 200 million for that. And I think really, this decision reflects our very disciplined approach to capital allocation and deal making. So just to reflect for a moment on the value that's being created. Well, when you look at it in rand terms, we've generated an internal rate of return of around 45% since January '22. And that's nearly a return of almost 3x money in a period of just under 3 years. And as I said right up front, we saw in this opportunity to make a very strong capital growth together with dividends. Over the period that we held our safe, remember, we initially bought around 21% in early 2022. We increased that stake over time to 28.8%. And we've generated a capital increase of EUR 69 million, which approximates to ZAR 1.5 billion. And over that period, we also received nearly EUR 40 million of dividends. So you can see, all in all, an exceptional return investment from the investment. And now it's about redeploying that money into our future opportunities. So what is behind our strategic agenda and our growth? If we look forward, it's now about the redeployment of the proceeds. The negotiated offer price presents us an opportunity to redeploy the capital into other assets that are strategically aligned and financially accretive. And I think you always hear me talk about those two phrases, strategically aligned, it's about retail. It's about the right types of assets that we always look at, financially accretive. We need to find deals that are even potentially marginally dilutive in year one, but by year two need to be neutral to positive. Ideally financially accretive from day one. And we felt that we could redeploy this money into assets at potentially better yields at significantly lower operational and deal execution risk. And those are very important points. So when we evaluated this as well, as I said, the deal execution risk was high. You had a competing bidder, now the bidder who could always, in a sense, trump you on your offer. It was never guaranteed. And the lower operational risk means that if we're looking at new assets, we do the due diligence from day one. Here, we'll be buying the assets with our due diligence because of the nature of it being a more corporate finance deal than an individual asset purchase. So that is really what we are planning to do with the money. We'll take the proceeds the EUR 200 million, which is our cash, we'll use some gearing on that as well and start opportunities, and we're confident that we have a very healthy pipeline to be evaluated. We remain deeply committed to our growth strategy in Spain and Iberia and Peninsula. And the decision to sell the stake should in no way be construed as losing confidence on the contrary, the proceeds are going to be redeployed into assets that we will own and control and we'll continue to grow in both of those markets going forward. As I mentioned, we have a very extensive pipeline of deals set to conclude by the end of calendar year 2024. And this will set Castellana to become one of the largest retail owners in Spain with a growing presence in Portugal and maintaining our strategic objective to achieve scale in Portugal as well. And therefore, you can see coming back to our initial goals of scale, they remain very much intact and so on. And scale is important, not for the sake of simply being able to say you big. Scale is important because I think it drives better relationships with your tenants. It brings better opportunities and potentially brings more capital because of people allocating money through ETFs, you do need scale to attract certain amounts of money and that's it. So it's certainly not something driven by ego, but it's something driven by solid business objectives overall. So I suppose the key question is what next, where do we move from here? As I've said, Castellana continues to actively and consistently source opportunities that are both strategically aligned and financially accretive in both Spain and Portugal. We intend to use gearing at around the 35% to 40% level at an asset level. And if we do that, we feel that we can target attractive cash-on-cash returns above our weighted average cost of capital. So all deals should be accretive that we are doing. As you know, we look for assets that offer strong, predictable and stable income, buying them at attractive yields, but importantly, with opportunity to add value over the short to medium term through active asset management. And you've seen, I think many of you have been exposed to the tremendous work that Alfonso and his team have done in the assets we've bought over the years. I think it's not about buying dry assets. We're looking to buy wet assets that can still be worked and add further value. Just again, to repeat, the Portuguese strategy is now really firmly on track. There was one outstanding CP, which was fulfilled. And the transaction successfully closed on the first of October 2024, and that was fully funded with the proceeds of capital raises from earlier in the year. The money that we raised in September will be deployed into the pipeline that I've been speaking about. As I've mentioned, Portugal, certainly, our plans here are not to stay at three assets. We are seeing good deal flow there. We do have some in the pipeline. So hopefully, that will become a growing area for our business as well. So there is potential deal activity in Portugal, and Castellana is actively evaluating other opportunities in the pipeline. And again, to stress, the funding is already in place should we proceed with these. And really due to our deep experience and the broad relationships in the market, we're really able to gain access to the majority of the retail opportunities in Iberia and invariably, these are an off-market deal. So we try not to get involved in processes. In other words, there are multiple bidders you tend to really just get the price bid up in those. So we tend to work on off-market deals. All the ones we've done historically have been off market. And the ones we're talking about now have also been sourced off market. So in conclusion, I think really, it's been our combination, our fusion of our underground asset management skills together with our corporate finance and deal expertise that has allowed us to identify mispriced asset opportunities, whether they are physical or listed assets as we did in Lar and then to deploy that capital across Spain and Portugal, thereby generating sustained value. At the same time, important just to say we remain very committed to growing South Africa. Up to now, we've been looking for assets. We haven't found them at the right price in terms of becoming accretive. I think that's starting to change. We're seeing our share price improving. I think our cost of capital is coming down and opportunities that previously were perhaps off the agenda are now starting to become more in focus. And then really, just to summarize with what we put out at our pre-close, we remain comfortably on track to at least meet our guidance for financial year '25, which is growth in FFO per share of 2% to 4% and growth in dividend per share of 4% to 6%, and that's coming off growth of nearly 7% in FFO last year. And 10% in dividends. So we'll provide a further update at interim results. But really, in summary, I think what we wanted to say is to highlight the story of a journey that has started with a very clear strategic objective of what we wanted to do, our ability to execute on that to drive value for our shareholders to make sure we're making the right decisions, disciplined decisions in allocating capital and really to say, banking of profit of ZAR 1.5 billion means we can now redeploy that capital into further opportunities and continue growing and adding value for our shareholder base. So with that, I will pause and see if we have any questions from the audience.

Our first question is from Nazeem from Investec, who asks, will you recognize income as part of capital received from Lar? There's a crude to be in the price. What is this number as a proportion of EUR 199 million up to December 2024?

Okay. Nazeem, so a number of issues in this. And number one, that's very important is timing, okay? Remember, the deal still has to close. And only when that happens, we'll then will we then be able to know exactly in what period would that dividend fall. And I'm going to come into more detail on that. We -- the timing is uncertain. We're led to believe that the CNMV, the Spanish regulator, should hopefully approve the offer towards the back end of October, but it's really up to them as to when they do that. But that's the indication we have. Thereafter, the offer will remain open for a period of time and then close. So I think we need to wait for that to happen before we start counting the chicken, so to speak, in terms of when the dividend is actually paid. Let me deal with the issue of the dividend because I think as many of you know, under Spanish SOCIMI Law, Castellana has got to distribute 50% of the capital gain arising from the disposal of its shares in Lar. And that is a figure around EUR 42 million. Lizelle, is that correct? Around EUR 42 million is the capital gain. Now that has to be done. In order for Vukile, to remain tax neutral, Vukile is required to then undistribute that 50% of the capital gain to shareholders. Now the problem that we face is the following. That is what the Spanish regulations require. If we look at South African SA REIT best practice, the stipulation there is that our reach should not distribute capital profits. And in fact, it's become the norm that South African REITs do not distribute capital gains. So you can see sort of that contradiction between the two issues that we need to work on. So Laurence Cohen, [ Deborah ], Lizelle are busy working on solutions to see how best to try and do that. It goes without saying that whatever we do will be in accordance with the regulatory environments in both jurisdictions. But payments of capital as a dividend is really not ideal from a shareholder point of view because really it leads a permanent erosion of the capital base. So what we need to do is try and find a way to limit the amount of capital paid out as a dividend whilst obviously complying with all the regulations and remaining tax neutral. That's a very important driver for us as well. And I think there are ways that we can look at that. And that is sort of through in a sense, having a higher retention ratio from, call it, normal earnings. But these are all issues that still need to be played out. We will expand on that at interim results, which is the last week of November, once we have greater clarity on timing. I think in terms of your modeling and what you're looking for, you should be working on a dividend payout ratio. As we've always said, of between 80% and 85%. Our goal is to continue to maintain regular growing growth in FFO and dividend per share, and that is our objective. We certainly don't want to try and get lumpiness, which is growing at 1 year. The market doesn't really value, if you have a drop after next year, the market doesn't remember they got their dividend in the previous year, and you have those challenges. So really, what we are doing is trying to find solutions that are obviously consistent with all the regulatory requirements, but doesn't create lumpiness in the earnings going forward, very much in line with the guidance of SA REIT best practice.

Great. Then another question from Francois du Toit from Anchor Stockbrokers. He says only EUR 26.7 million out of the EUR 38.4 million dividends received from large day were accounted as distributable income up to FY '24. Does this imply there will be significant catch-up contribution to distributable income in FY '25? And can you quantify the contribution to DI in euros to Castellana in FY '25, assuming the disposal concludes by 30th of November.

Lizelle, are you able to take that one?

Sure, Laurence. I think it talks to your previous comment in terms of how we will be balancing the different legislations in terms of SA REIT best practices, as well as the SOCIMI Law. However, for our financial year for '24 as well as '25, we will remain consistent with our policy to accrue the monthly equivalent of the EUR 0.70 per share based on Lar's most recent normal dividend that they declared. There will also be, in a sense, a catch-up for any prior year under accruals which is also going to be consistent with what we've done in the past.

And a question from Mweisho Nene from SBG Securities, says it seems the focus for future deals is Iberia. However, considering you are looking at CRP earlier, is U.K. retail a likely destination if good deals are not found in Iberia?

Mweisho, thank you. Yes, we did look at Capital & Regional. We unfortunately couldn't reach terms, so we walked away from there. I think that is probably more in the realms of an opportunistic purchase, what we thought was a very attractive entry point into the market. As we speak, we're not currently evaluating anything in the U.K. It's not on our agenda. But I think really what we need to do is sort of run two parts to our strategy. One is sort of what is the strategy, which is very much Iberia, Western European focus, primarily Spain and Portugal. We're not actively looking at any other markets at this stage. But we always stay opportunistic in terms of ideas where we see great value creation. We thought that might be the case in Capital & Regional. But I think what you can expect from us for the next, I don't know, foreseeable future, is focusing on Spain and Portugal, not looking at other markets. We have found, as I said already, the first three Portuguese deals. There are a few other deals that are currently under evaluation. We need to hopefully close those, bid those down before we start moving on to the next opportunities.

Perfect. Then final question is another one from Francois du Toit of Anchor Stockbrokers. He says cash balances were elevated at FY '24 and have increased with the book build since. Can you indicate what interest rates you are earning on cash at the moment?

Lizelle?

Our money market investments saw earning interest at a rate of 9%. We also have another short-term investment where the funds will be held until the end of November, and that investment is earning 13%.

That's all the questions.

Great. With no further questions. I'd just like to again thank you all for your attendance. We are very upbeat about the outcome. We are very excited about the prospects going forward. And we look forward to sharing an update with you at results at the end of November. Thank you all for your time and attendance.