With a publicly traded reference value for its Asia-Pacific division (through its 55% stake in Australian listed Leighton Holdings) the current HOT AG share price implies a bottom €-1.7 equity valuation for the total of its non-Asian operations (‘non-Leighton stub’).
Given the limited downside and a conservative target value of €25.1 for the stub, we recommend to go long the non-Leighton stub at current prices: As 66.5m Hochtief shares own 163.8m Leighton shares, the long non-Leighton stub is set up by buying 1 Hochtief share and shorting 2.46 Leighton shares. With clear possible catalysts, we expect the value of the stub to be realized over the medium term (3-9 months).
At current Hochtief and Leighton market prices, the non-Leighton equity stub is valued at €-1.7 a share:
- On average, the stub has traded around €7.6 since 2006. (average €18.9 in 2006; €14 in 2007 and €-5.9 in 2008).
- Even allowing for off balance sheet debt, the current stub valuation implies EV/Sales 2009 of 0.2x and EV/EBITDA 2009 of 4.6x (assuming 10% below the 2009 company guidance in line with 2008 numbers) versus Europe Construction peers at EV/Sales 2009 of 0.7x and EV/EBITDA 2009 of 7.5x; American Construction peers at EV/Sales 2009 of 0.5x and EV/EBITDA 2009 of 6.5x; European airports at EV/Sales 2009 of 4.0 and EV/EBITDA 2009 of 10.7x; Outsourcing Services peers at EV/Sales 2009 of 0.7x and EV/EBITDA 2009 of 8.7x.
- After applying a 10% conglomerate/holding/NAV discount (in line with the European conglomerate average) to a Mark to Market NAV valuation driven by: a) company guidance mid-range valuation for its Concessions business, b) a valuation in line with its peers for its Services, American and European businesses, and a highly conservative value for its Real Estate division, we achieve a target price of €25 for the stub.
- Downside risk: Applying an excessive 30% conglomerate discount to a bear case valuation, using: a) the company bottom valuation for its Concessions business, b) allocating no value for its European business, c) assuming below company guided earnings for its Services and American business, and a highly discounted (‘fire sale’) value for its Real Estate business, we achieve a stub value of €-3. (Applying a 40% discount would give stub value of €-10)
Well defined catalysts for stub value realization:
- At its 1H09 results, Hochtief (aware of the stub valuation mismatch) said it was looking at strategic options for its Concessions business (64% of stub valuation), either by IPO or sale to a strategic investor. Such corporate activity would increase the transparency of the conglomerate and increase/realize the value of the non-Asian stub. Given that Hochtief has already shortlisted several banks for the transaction (DB, Commerzbank, Morgan Stanley, HSBC and WestLB), we believe such a transaction could be completed in the next 3-9 months.
- ACS, its 29.9% investor (just below the mandatory offer threshold), could be interested to make a full (mandatory) take-over bid for the company as: a) it might want to diversify its geographical reach away from Spain (2008: 78.4% of total sales), and b) it may wish to benefit from the reduced 18% capital gains tax on its Union Fenosa gains (instead of the normal 30% tax) if it reinvests its funds from the Union Fenosa sale within 12 months of the Union Fenosa deal closure. Given that the Union Fenosa deal completed in Apr-09, ACS needs to reinvest its funds (ACS received about €8bn for its 45.3% Union Fenosa stake) by Apr-10 if it wants to benefit from the reduced 18% CGT.
Inherent value stub:
- Despite extreme conditions in its markets and declining order books by its competitors, Hochtief has stuck to its guidance of flat profits for 2009, and has already seen increases in its order books.
- Given the market leading position of its US businesses (Turner: market leader in green buildings, education and healthcare; and Flatiron: large player in transport infrastructure), Hochtief is one of the companies poised best to benefit significantly from the worldwide economic stimulus packages, especially with respect to the $100bn package. This would come on top of Hochtief’s current €33.1bn order book, which theoretically provides the group with work for the next 1.5 years already and should be in a comfortable position to weather the temporary downturn.
- Unfreezing of the credit markets should help Hochtief realize valuation premiums over the book value of its property development portfolio: currently Hochtief recognizes these assets by their production cost and are being rented out. Hochtief is not seeking to establish a rental portfolio property, but will focus on selling these when debt becomes more readily available, generating further value. (Although we applied a steep discount for this division due to current disposal risk, we believe these numbers should significantly improve in the medium-term).
- Value for European businesses: Although loss-making for the last couple of years, management has implemented a large-scale restructuring process (by diversifying more operations outside Germany) and is now targeting 1% EBT margin for 2009 and 3% EBT margin for 2010: any extra 1% EBT margin would contribute around €4 value per share.
-Airport traffic recovery: As experienced in previous downturns, air traffic recovered strongly (Airbus expecting CAGR of 4-5% for global air travel for 2008-2027). Above average growth could be experienced from its exposure to more immature airports as Tirana and Budapest.
Disclosure: Long Hochtief - Short Leighton Holdings