As a background for new investors, Principal Investments is the segment where Catella makes property investments using its equity. We approach the valuation of Catella using a sum-of-the-parts (SOTP) method, where the assets’ value directly determines the value we put on the segment Principal Investments. The total debt position, whether concerned with Principal Investments or the group as a whole, is then accounted for when calculating net debt. 

Until now, we have calculated Principal Investments’ asset values by adding our estimates of potential profits (when divesting the projects) to the item in the balance sheet called “Development and project properties”. However, our updated view is that several other items on the balance sheet’s asset side are also related to Principal Investments’ assets. These are: 

Depending on whether a project is divested or not, as well as the degree of Catella’s ownership in the subsidiaries, the classification on the balance sheet varies. To our understanding, the above items relate to the projects in Catella in the following way: 

As evident from the table above, the values of the projects do not exactly sum up to the corresponding items on the balance sheet. This is a result of us sometimes using values from the Principal Investment table, and sometimes using items from the balance sheet. Additionally, Principal Investments is not the sole component of the corresponding balance sheet items, so there are sometimes assets from other segments included on the balance sheet as well.

Our method is potentially overstating the fully consolidated projects, but understating the projects that are not consolidated. This is a result of Catella having to use the equity method when valuing the unconsolidated projects. The equity method requires the company to record assets at historical cost, and then adjust the value for its share of profit or loss in the subsidiaries. As development costs in the subsidiaries are sometimes charged directly over the income statement, holdings in subsidiaries are not properly reflected on Catella’s balance sheet. In addition, loans to subsidiaries are netted against equity, which also understates the values. Taken together, we think these two factors should offset each other relatively well, and the value of SEK3,040m should reflect the underlying values well enough.

With the new classification of assets, we argue that it is worth setting the company’s balance sheet in relation to the current market capitalization to highlight its strength. Our method resembles the classic method for calculating a company’s enterprise value, where we treat the project-related assets as "cash".

By treating project assets as “cash” in our calculation, we illustrate a scenario where all projects are divested. Other than adding a small net profit to the sale of Kaktus, we refrain from speculating on potential profits for divesting properties given the current market climate. The values we use in the calculation for the enterprise value are derived using the same methodology we described in the section above.

It is worth noting that Catella targets a 20% IRR on its equity investments within Principal Investments. In previous sales, the returns have often far exceeded this target. By valuing the projects at the book value, our base case builds on the company generating an IRR of 0%.

All in all, the new treatment of assets has a positive effect on our valuation. Our estimated value for Principal Investments goes from SEK2,301m to SEK3,370m in our Base and Bull Case. The impact on our Bear Case is smaller as we estimate all fully consolidated projects to be sold at 90% of book value and exclude the forecasted SEK132m in net profit from Kaktus.

In our Bear Case, we also reduce the estimates for normalised EBIT for corporate finance, which reduces our valuation somewhat. Additionally, we lower the 2025e multiple for IM to 7 (8).

In all scenarios, the net cash position is reduced, as one of the items in the balance sheet was previously classified as a part of liquid assets (wrongfully) and is now moved to Principal Investments instead. 

Our new fair value range is SEK26 (26) to SEK74 (69), with a Base Case of SEK54 (50) per share. 

Our new Base Case valuation is outlined below.

To make sure that our new classification of assets in Principal Investment was correct, we had the opportunity to sit down with Catella’s (relatively) new CFO, Michel Fischier. Other than educating us in fundamental accounting matters, he spoke about the market, the company’s strategy, and real estate valuations. We provide our three key takeaways from the conversation below.

As we mentioned repeatedly in our research update following the Q3 2023 report, the market for real estate, especially in terms of transaction volumes, is at historical lows. We will not go into more depth on the issue but found some aspects which we consider interesting. Some of them are likely to be old news for recurring readers of our research.

First, a new type of investor is entering the market. Much of the capital looking for what Mr. Fischier calls “core” assets (properties with stable cash flow and a yield of 4-5%) has been drying up. Instead, opportunistic investors looking for distressed assets have become more common. Often, forced sellers find themselves in situations where their properties are underwater in terms of debt and are unable to make the investments required to bring them back to the surface. In these situations, opportunistic buyers emerge and are able to find attractive returns through buying these assets, making the necessary improvements, and then moving on. Improvements can include converting offices to apartments, increasing the quality of the tenants, and making value-add renovations to the properties. This trend is benefitting Catella’s IM business area, first and foremost through mandates in Asset Management.

Second, it has not been fully possible to utilise a strong balance sheet during 2023. At first glance, the set-up during 2023 is ideal for Catella. A robust balance sheet in a weak market should enable opportunistic investments. However, given the large discrepancy in expectations between buyers and sellers, the prices are yet to come down to a level at which investments can generate really attractive returns. As such, the benefits of having a strong balance sheet during 2023 have not necessarily been reaped by making fantastic investments, but rather as a result of not having to sell good assets at distressed prices.

Finally, Mr. Fischier is cautiously optimistic about the market going into 2024. Although valuations are unlikely to rebound significantly, expectations should merge. As the buyer-seller discrepancy is reduced, more transactions should be possible. Theoretically, this will enable Catella to put more of its strong balance sheet to work.

Another interesting market dynamic is the separation of prime real estate assets and properties located in B or C areas. Whereas the latter has taken a large hit due to rate hikes forcing yields higher, the former has been resilient or even increased in price over the past year. The reason for this can be traced back to the dynamic that underpins luxury goods’ outperformance during recessions. Although the combination of expensive wares and bad times intuitively feels off, there is always a select few that are in the market for high-end products. Evidently, this dynamic seems to be in play both when talking about handbags and real estate investments.

This speaks well for Kaktus, Catella’s largest individual investment made using its own equity. The property is in a prime location in the centre of Copenhagen, and like most prime locations across Europe and the Nordics, prices seem to have held up well. Regarding Kaktus, Mr. Fischier also spoke, as we have learnt previously, about the need to secure all tenants before selling a property. The underlying demand for this type of asset remains strong, but all the practical details must be in place for the buyer to be willing to pull the trigger. The reason buyers want more security is that what is called forward-funding has dried up recently. Previously, buyers have been confident in agreeing to pay for the property in the development stages, and then access the building once it’s finished. This shifts the balance sheet risk from the seller to the buyer earlier in the process, and the buyer then must be sure that the seller can indeed finish the project. This is something that is much more uncertain in the current market climate than it was three years ago, and as a result, projects are generally sold in later stages than previously.

When asked about Catella’s strategic objectives for the next year and beyond, Mr. Fischier said that growth is on the agenda. We have previously talked with Catella’s Head of Capital Raising, Gianluca Romano, where he told the same message. Asset Management and distressed assets are likely to drive growth in the short run, but increasing ticket size is likely to be the important driver in the medium to long term. Catella has historically leveraged its local expertise with great success (as evident from IM’s 20%+ CAGR in AUM since 2015), and the company now sees an opportunity to attract global institutional investors to several of the company’s different offerings in one go. In essence, shifting somewhat from a bottom-up approach that leverages the local expertise, to a top-down approach that raises capital to all Catella’s different funds from the same investor.

With more capital to allocate, we were curious about the challenges associated with scaling the organisation to find enough potential investments. Mr Fischier stated that, naturally, finding talented people is an important part of management’s job, and they work hard to ensure that local CEOs in the company’s subsidiaries keep ownership stakes in order for incentives to be aligned.

We also learned some further details about the stability of Catella’s core offering. To begin, the investors in the IM funds, both current and future, are investing with a horizon stretching into the decades. Making inflows stable and somewhat predictable. Additionally, if an investor is to withdraw capital from the funds, there is a stipulated twelve-month period from the time funds are demanded until they are paid out. This should discourage sellers from making decisions in haste, as well as forcing distressed sellers to divest assets where it takes less time to receive the money. Finally, we also learned that the investor base of IM is very diverse, with no individual investor representing a significant part of the funds. According to Mr. Fischier, with the type of business model IM applies, it is actually quite difficult to have high concentration among investors. The reason is simple, in the case of a need for liquidity, investors do not want to have, say, 10% of all the assets in a specific real estate fund, as it would be very difficult for the investment manager to divest such a significant portion of their assets base with short notice. As a result, Catella’s “customers” are generally quite keen on ensuring that they do not represent too large a portion of a fund.

This research update can be summed up by saying that Catella seems to be standing on a solid core, as we have highlighted previously. Fund mandates are long, sticky, and predictable. Additionally, the balance sheet is even stronger than we thought previously. All in all, Catella should be well-positioned for a potential normalisation of the real estate market during 2024 and 2025.