German landlord tie-up risks political subsidence

3 minute read

Apartment buildings are seen in Berlin, Germany, August 29, 2019.

LONDON, May 25 (Reuters Breakingviews) - Vonovia (VNAn.DE) Chief Executive Rolf Buch is selling political-risk insurance to shareholders of Deutsche Wohnen (DWNG.DE), a rival German landlord. It’s a dangerous strategy, particularly in an election year.

At first glance the tie-up between Germany’s largest listed landlords, announced late on Monday, looks shrewd from the perspective of Buch and investors in his 28 billion euro group. Vonovia is offering roughly 18 billion euros in cash for Deutsche Wohnen’s equity. That’s about 25% above its volume-weighted average price over the last three months, but no more than the latest book value of its property, after taking off debt.

The gap exists because Deutsche Wohnen has been trading at a discount to its net asset value, largely because of political opposition to landlords in Berlin, its biggest market, where lawmakers have tried to freeze rents and activists want to “expropriate Deutsche Wohnen”. Buch is effectively indemnifying shareholders against future interventions by allowing them to cash out at book value. In return, he gets 160,000 apartments and the chance to wring out 105 million euros of annual cost savings.

The question for Vonovia shareholders is whether those rewards are worth the risk of becoming the new punching bag for politicians in Berlin and elsewhere. The 6% decline in its share price on Tuesday morning suggests not.

First, the cost synergies aren’t worth all that much. Taxed, capitalised and net of integration costs, they’d have a present value of 650 million euros, compared with a takeover premium of almost 4 billion euros. Granted, Buch could cut more costs over time, as greater scale allows him to source cheaper materials and labour.

But even if the synergies double to 210 million euros per year, Vonovia’s return on invested capital from the deal would be just 2.6%. That’s based on Breakingviews calculations using a 19% tax rate and the median Refinitiv estimate of Deutsche Wohnen’s operating profit for 2023. The sector’s cost of capital is probably above 3%, according to a person familiar with the matter.

Buch has sealed the approval of local legislators in Berlin by limiting rent rises until 2026 and offering to sell the city 20,000 apartments. But politicians can always change their mind, especially with an election due in September. The risk for Vonovia shareholders is that Buch’s ambition puts a giant target on the company’s back.

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- Europe’s largest residential property group Vonovia on May 24 said it had agreed a takeover offer for its closest German rival Deutsche Wohnen, valuing the company’s equity at about 18 billion euros.

- Vonovia will pay 52 euros per share and Deutsche Wohnen investors will retain the rights to a 1.03 euro per share dividend.

- The offer represents an 18% premium to the company’s May 21 closing price and is 25% above the volume-weighted average price of Deutsche Wohnen shares over the previous three months.

- Vonovia said it estimated that a deal could unlock 105 million euros of annual cost savings. It is funding the deal with 22 billion euros of bridge financing and an 8 billion euro rights issue scheduled for after the transaction closes.

- Deutsche Wohnen, whose buildings are mainly located in Berlin, said it backed the offer.

- To secure support for the tie-up in Germany’s capital city, the two companies pledged to limit regular rent increases to 1% per year there for the next three years and to inflation up until 2026.

- Deutsche Wohnen shares were up 7% to 52 euros as of 0725 GMT on May 25, while Vonovia shares were down 6%.

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