Phoenix Spree Deutschland Appears to Change Strategy

In the April newsletter we rated Phoenix Spree Deutschland (PSDL, 194.75p) shares as a hold after the trust suspended its dividend because of a sharp drop in condominium sales. After speaking to the managers we felt we understood the reasoning.

The shares have been steady since, but we were a bit taken aback by an announcement the trust made on 5th June, ahead of its AGM on 28th June. The board has been discussing fees with the managers QSix Residential, and is proposing a fee change for one year, starting on July 1st. Interestingly, the proposal does not require shareholder approval under the Listing Rules, but the board has decided that it should nevertheless be put to shareholders. This rings some alarm bells for us, suggesting the board feels the need to seek additional legitimacy here.

The background, as we noted in April, is that the trust’s core rental business in Berlin remains strong, and its debt financing is secure, but in common with many other REITs the shares have slumped to a very wide discount to the net tangible asset value. The generation of cash to pay dividends was largely dependent on asset sales, but these have been difficult to implement at prices that reflect the long-term value of the properties. Accordingly, the dividend was suspended to avoid pressure to dispose of assets at prices that may not be in the best interests of shareholders. So far we think this all makes sense.

The next part looks like a sharp u-turn. The trust’s latest announcement says it is marketing properties for sale and that these may be at a discount to the carrying value. It goes on to say “plans to bring additional condominium properties to market have also been accelerated. Any surplus cash generated over amounts required to reinvest in the company's existing portfolio and reinstate dividends on a sustainable basis will, so long as the material discount to NTA persists, continue to be used principally to return capital to shareholders and not to acquire further properties. This enhanced disposal activity will be the primary focus of the company's strategy for at least the next 12 months.” So now it sounds as though the board has decided to pursue a more aggressive program of asset sales at prices that we presume have not improved over the last few months as the German economy has gone into recession. And this is what the change of fee is about – to incentivise the managers to sell more properties or indeed to cultivate an offer for the entire portfolio. The managers were paid €7.4m last year, but the proposal is now to cap fees at €5m with the add-on of a 1% disposal fee of the gross value of assets sold over the twelve months from July 1st. To match last year’s fee the managers will need to sell €235m of properties, representing 30% of the last reported gross asset value.

We are perplexed by this apparent sudden change of heart and change of strategy. The trust seems to have shifted from its long-term mindset that meant it did not want to be selling assets during periods of weakness to a completely different short-term plan to generate cash, reinstate the dividend, buy back shares, and narrow the discount. With the shares on such an enormous discount of 54% we can see the rationale, and it may work to the advantage of shareholders, but what we really don’t like is the way in which this potentially major strategic shift has been explained – or rather, not explained - to shareholders. It diminishes our confidence in the governance of the trust somewhat, though at the same time we also hope this change might help to light a fire under the share price. Our rating stays at HOLD, but with some sense of elevated risk. We suspect there may have been some shareholder agitation behind this shift, in which case the vote will likely sail through, but we think some holders with a longer-term view may not want to support the proposal. We’ll be keeping a close eye on this one.