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Aveo Group Now A Binary Proposition

Australia | Jun 26 2019

Struggling retirement village developer Aveo Group may have been thrown a lifeline by a potential suitor, but the picture is not pretty if the deal falls through.

-Guidance materially downgraded
-Potential offer in process
-Downside risk substantial

By Greg Peel

A strategic review by retirement village developer Aveo Group ((AOG)) has drawn out a potential takeover proposal. We don’t know who from yet and nor is there any price indication at this point, but we do know the proposal is non-binding and indicative only.

In other words, there are no guarantees, even after the unknown suitor has undertaken extensive due diligence.

Aveo has given the suitor until July 22 to come up with a definitive agreement, leading to a Scheme of Arrangement, or there will be no deal.

Aveo’s trading update provided profit guidance substantially below broker forecasts. The company has written sales on 1,111 units in FY19 but settlements are running well behind, leading to cash management headwinds.

If Aveo can reach 900 settlements in the period as management has indicated, it will still be a lower result than the 974 settled in FY18, Macquarie notes, driving net debt higher and resulting in negative free cash flow.

In an interesting move, the company will alter its accounting model to one of development recognition at time of settlement rather than practical completion. Brokers agree this is a more conservative approach, and given settlements lag completions, more realistic. But the interesting part is that Aveo is not planning much in the way of development in FY20.

Thus as long as outstanding inventory can be sold in the period, the company’s profit will look much better.

Nevertheless, Aveo is a company suffering from deteriorating underlying fundamentals in a difficult housing environment. Brokers have materially downgraded earnings forecasts. The stock is now trading at a substantial discount to its net tangible asset valuation (NTA).

And that means it could well be attractive to a private suitor. Macquarie expects any bid price to still represent a discount to NTA, and this may just be a fair outcome for shareholders on the basis that if there is no deal, the stock is likely to continue to materially underperform.

Morgans agrees it would make sense to privatise a large and mature portfolio of retirement assets at this stage in the cycle. Assuming a 30% control premium on top of the broker’s valuation implies a price of around $2.35 per share.

Moelis also sees it as an opportune time to acquire Aveo at the bottom of the residential cycle, and at a deep discount to NTA, assuming the residential market is now set to recover, and assuming the potential to sell down as yet unsold stock. Given the due diligence underway, the downgrade to FY19 guidance should come as no surprise, Moelis suggests.

There is no certainty of an outcome. If there is no deal, the stock would materially de-rate, Morgans believes. A position in Aveo is thus one of binary risk. Any offer will likely provide at least some upside, and an “out” for investors, but no offer would open up yawning downside.

Uncertainty? Moelis rates Aveo a Buy, Morgans a Hold and Macquarie a Sell (Underperform).

Moelis has a target of $2.50, Morgans is at $1.81 and Macquarie at $1.61.

Pass the coin please.

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