Adler - Thoughts
All,
Please find our unchanged analysis here.
So despite the intense media coverage of Adler since October last year, there still seems to be a significant information asymmetry among market participants. KPMG on Friday turned out to have left their report open to interpretation as the forensic division had failed to commit to a conclusion of their report. Moreover, a few more topics have come up in the subsequent call held by Adler that are now impacting its trading performance. Since then we have had the opportunity to discuss the situation off-record with various legal advisors in Frankfurt.
Substance:
- Going by substance, and by overall length of time of the investigation, we consider 6 months as adequate and the overall potential for value correction in line with our thoughts.
- KPMG did confirm many of the too-close-for-comfort relationships with the cluster of investors around Cevdet Caner. However, even after digging for six months in the company’s archives and conducting interviews within and outside of Adler, there seems to have been no evidence of significant abuse. The sheer number of pages dedicated to Cevdet Caner’s consultancy contracts document the lack of concrete findings.
- That Adler’s corporate governance is weak did not need ghosts to come from the grave to tell us that. Viceroy have laid that bare abundantly.
- KPMG Forensic have attempted an alternative valuation of the company’s construction properties, which was of course always to come out lower than the company’s. KPMG Forensic are not property experts, but the HY market agrees and the findings in total are not too dissimilar to ours - even if arrived at in a different way. If Adler were to make these corrections and use KPMG Forensic as valuation agent, the resulting write-offs would not shock us, but they would still shock the average investor. That is also where we went wrong a little recently.
Bonds / Shares down - No conclusion:
- The process on the ground as described by Adler sounds absolutely plausible. KPMG Forensic have had 6 months to digg in the dirt, found a lot of the information in the Viceroy report to be true, but have been unable to confirm the allegations of actual wrongdoing to any significant degree. Shortcomings came from both sides, with KPMG asking for an unreasonable mountain of information, including emails they would take 10 years to read and the company being apparently unable to produce documentation where it would have been reasonable to expect it to.
- In a 6-month process of this kind, it is however entirely normal to have unfulfilled wishes on either side. So we see the current surprise over these issues as overdone.
- However, from KPMG Forensic’s point of view, the process was cut short (if for valid reasons) and not all information has been supplied. Also the mission (like many forensic tasks) was difficult: to determine whether there was fraud or not. As Adler said on the call: it is easy to determine fraud if you find it. But it is not possible to determine that there has been no fraud only because you can’t find it.
- So the partners involved will want to cover themselves and as with any good investigation, reaching the limits of what a company can provide allows KPMG not to have to draw the “negative conclusion” of No Fraud under the time pressure set by the credit documentation.
- So the absence of a conclusion is regrettable, but we accept the reality of this kind of process.
Bonds / Shares down - Qualified Audit Opinion:
- This is new. KPMG Audit have decided that because the forensic process was cut short / stopped short of clearing the company, they would qualify their audit opinion - or something along the lines. This is understandable from the Auditor’s perspective.
- However, it does put Adler’s securities beyond the pallet of in particular two groups of investors:
1) small unsophisticated investors who rely on a clean audit opinion for basic DD.
2) large professional investors who at a later date would struggle to justify holding these securities if something went wrong in the end.
Shares down - No Strategy:
- For the first time, the call brought up the subject of a longer-term strategy, once the current travails would be felt with.
- Adler is small when compared to some of its larger and recently merged peers. Scale is important and the feasibility of continuing a strategy of organic growth, now that Adler has shrunk - is still shrinking needs to be considered carefully.
- Those investors looking at fundamental value - like we do - may not mind as much, but many other equity investors, in particular, will be lacking a story. So they’ll buy something else instead.
Bonds down - KKR deal not done yet:
- Management on the call somehow evaded a question on the subject, although it may have been down to a misunderstanding and perhaps the subject is far fetched. But it appears the KKR deal has not yet been executed.
- The question had been about any link between execution of that deal and the outcome of the investigation. Management seemed to deny that and hinted at how KPMG have found the assets in question to be valuable in line with book.
- Management also stated that they are sleeping well at night with respect to that transaction.
- The deal is however key to Adler’s liquidity projections and we did not receive a reason for the delay of its conclusion. So investors should be that little bit more concerned about CF, although we are sure there would be other deals lining up if this one would fall through.
Informal discussions with legal advisors:
- The resounding interpretation in Frankfurt is that Bafin could not possibly have been seen to terminate their investigations even before the KPMG report comes out. That would have been a political disaster. So that Bafin say their investigation is still ongoing is only natural.
- That Bafin or the State Attorney have made significant findings they would have withheld from KPMG Forensic is equally unlikely. So we can conclude that they hold nothing beyond what we have.
- They now that the report is out either of them or both decide to launch their own investigation is therefore considered very unlikely. If either office made such a decision, they would: start a process with low prospects of being successful and should they not find anything, but in future something does come to light, after all, they would just risk egg on their faces. From the regulator’s perspective, it is, therefore, better to focus on Adler’s efforts to improve its corporate governance and the State Attorney is likely to move on.
Positioning:
- The grand conclusion, therefore, remains that Adler continues as a going concern and that our converts are being repaid later this year.
- The fundamental value underpinning a €17 share price we have flagged back in November is also still intact and if anything is being substantiated by KPMG.
- We view the qualified audit opinion as an unfortunate, but transitory problem that will make capital market transactions more difficult in the next year. However, we see asset coverage strong enough to allow Adler to remain liquid as it navigates this period.
- We are therefore remaining long both Adler shares and Aggregate 5.5%s and are considering taking a further 1% in the Adler shares while trading at these levels.
- Adler are publishing their annual report on Friday - all eyes on write-offs and the audit opinion.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003