Rating action

Scope Ratings affirms ADLER Real Estate AG’s issuer rating of BB and senior unsecured debt rating of BB+. The Outlook remains Positive.

Rating rationale

On 23 September 2019, ADLER announced the signing of an agreement to acquire all of the shares in ADO Group Ltd. for a total consideration of EUR 708m. The acquisition of ADO will be an all-cash transaction, predominantly financed through a bridge loan. ADLER intends to repay the bridge loan by early 2020 using a combination of a rights issue (fully guaranteed and backstopped by several existing ADLER shareholders), cash from the disposal of non-yielding assets, and financial debt. Scope considers execution risk to be low, since ADO Group shareholders with 52% of voting rights have committed to support the transaction. However, the transaction is still subject to approval from the extraordinary general meeting of shareholders (expected by early November).

This acquisition will provide ADLER with a significant stake in ADO Properties S.A., a German residential real estate corporate holding around 22,000 residential units solely in Berlin.

Scope expects ADLER’s business risk profile to improve due to gains in size, higher asset quality and greater exposure to the residential segment. However, the rating is constrained by the increasing exposure to regulatory risk, which could limit future top line development. ADLER’s relatively weak financial risk profile, with future leverage dependent on the successful refinancing of the transaction planned for early 2020, is also negative.

Business risk profile

Please note: On 26th September 2019, ADO Properties S.A. announced that it entered into an agreement with Gewobag Wohnungsbau-AG Berlin, a government related social housing provider, to sell 5,800 residential apartment units from its portfolio. Scope did not adjust for the impact of the announced transaction on key performance indicators of the group’s consolidated business risk profile, given the limited public visibility of such indicators for the portfolio that will be sold.

A successful acquisition of ADO Group Ltd. is likely to improve ADLER’s business risk profile, predominantly due to:

• Lower industry risk because added exposure to the residential segment (ADO’s core business segment) lowers relative exposure to the higher-risk development segment.
   
• A significant improvement in ADLER’s market positioning with total assets up by EUR 4.4bn to around EUR 9.4bn and funds from operations growing to above EUR 130m (based on the last twelve months to end-June 2019 on a fully consolidated basis with no adjustment for ADO’s announced portfolio disposal of 5,800 residential units).
   
• The enhanced granularity of the residential tenant base due to the addition of 22,169 residential units from ADO Properties SA, lifting the total portfolio to around 80,000 residential units. However, ADLER will rely more heavily on economic and regulatory developments in its top three markets, which will represent 44% of net rental income (Berlin: 33%, Wilhelmshaven: 6% and Duisburg: 5%) compared to 27% as at end-June 2019. Scope especially highlights the regulatory risk for the Berlin portfolio to be acquired through ADO Group Ltd. because of the city’s decision to freeze most rents for five years. However, the rating agency believes that related risk is partially mitigated by the relatively low acquisition price, with a 15% discount to EPRA net asset value and an implied fair value of EUR 2,400/sq m, which is slightly below the replacement cost.
   
• Improved occupancy rates to around 95%, up from 93.6% as at Q2 2019 (ADO Properties SA’s occupancy stood at 97.1% as at Q2 2019), expected to remain at high levels given the good asset quality of ADO’s portfolio (100% located within Berlin’s city borders and 37% in central locations).
   
• The addition of ADO’s portfolio following the acquisition may slightly increase ADLER’s profitability, as measured by its EBITDA margin. Scope estimates that the margin will remain above 60% but believes that the regulatory framework in Berlin may jeopardise further improvement.

Financial risk profile

Scope expects ADLER’s financial risk profile to remain unchanged following the acquisition of ADO Group Ltd. This includes the implementation of the acquisition funding plan, which combines a rights issue, cash from disposals of non-yielding assets, and the funding of the remainder with financial debt. Scope anticipates that the company’s leverage will continue in line with its rating case, with loan/value expected to decrease to below 60% by YE 2019 and EBITDA interest expense expected to slightly improve to levels above 2.5x, benefitting from the lower cost of ADO’s debt.

Outlook

The Outlook for ADLER is Positive and incorporates Scope’s expectation that the company’s business risk profile will continue to improve, benefitting from the further upscaling of asset quality, measured by higher occupancy, the like-for-like growth of rents above inflation rates and the addition of assets (‘Wasserstadt Mitte’) in strong locations. ADLER’s business risk profile will also benefit from improving profitability, with EBITDA margins forecasted at around 60%. The Outlook further reflects Scope’s expectation that ADLER’s financial risk profile will remain stable. Scope anticipates that EBITDA interest cover will stay above 1.9x, and that leverage will decline to around 55% within the next 12-18 months.

Rating-change drivers

A negative rating action is possible if debt protection, as measured by EBITDA interest cover, decreases below 1.5x or if ADLER’s access to external financing weakens.

A positive rating action could be warranted by an improvement in ADLER’s financial risk profile, i.e. if EBITDA interest cover were to remain above 1.9x and the loan/value ratio were to fall below 55%, both on a continuing basis.

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for this rating and rating outlook (Corporate Rating Methodology; Rating Methodology: European Real Estate Corporates) are available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Philipp Wass, Executive Director
Person responsible for approval of the rating: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 25 July 2016. The ratings/outlooks were last updated on 16 April 2019.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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