In the aftermath of the call and the earnings release last week, interested parties may be looking for conviction to step down either side of the proverbial fence on Adler. New board chairman, Dr Stefan Kirsten, has certainly conveyed a strong message of new beginnings and a stable footing. Just as following the company’s call to discuss KPMG Forensic’s findings on 22 April however (more here), uncertainties remain, as key questions raised during the earnings call were not clearly or directly answered.

Some questions not immediately answered were subsequently addressed, following the chairman ostensibly receiving texts from colleagues offering the answer. KPMG Luxembourg, the company’s auditor, also issued an update to its original statement on its audit opinion during the earnings call, clarifying that it had issued audit reports which included a disclaimer of opinion on the annual accounts.

The covenant implications of audit uncertainty; opinion disclaimer prompts board reshuffle

There was a large sell-off in capital markets on Monday in response to auditor KPMG’s inclusion of a disclaimer of opinion in Adler’s 2021 annual report, something that the FT appeared to first pick up on and interpret as a refusal to offer an audit opinion over the weekend. Bonds opened more than 10 points down on Monday morning as the market digested results that were published late Friday afternoon.

The implication from a bond covenant perspective is that the company is required to publish audited annual accounts within 120 days of the period end. There are also other possible inferences to derive from KPMG’s decision, though many of those will have been pondered since the special investigation report was published on 22 April.

We also learned on Saturday that the board of directors at Adler had collectively offered their resignation with immediate effect in response to the audit disclaimer. Only three resignations were accepted by the chairman, with Thierry Beaudemoulin (co-CEO, now CEO), Thilo Schmid and Thomas Zinnöcker asked to retain their positions to ensure the continuity of business.

A new CFO is also currently being sought with Dr Kirsten revealing on the earnings call that he was in discussions with two potential candidates but that the situation was ongoing. The decision to retain Thilo Schmidt as head of the audit committee was questioned during the earnings call due to his prior involvement; Kirsten responded to say that shareholders will decide on the applicability of that decision at the AGM on 29 June.

As to whether the 2021 annual accounts are indeed audited, on which there appeared to be uncertainty, Dr Kirsten has been clear that the accounts have been audited and that the “covenants are intact”. He referred to a legal opinion the board received from White & Case that covenants in this regard had been fulfilled. When asked whether said opinion would be published, he responded to say that it would be as long as W&C agrees. As of writing, it has not been published.

Dr Kirsten was also clear that KPMG’s initial statement regarding its disclaimer of opinion was an “obvious mistake because it’s not in line with the standards”. KPMG updated its statement during the earnings call, clarifying that it did issue an audit report, including disclaimers of opinion.

Viceroy issued a “conference questions” release just prior to the earnings call, refuting claims made by Adler. In summary, Viceroy posits that it is a fabrication that the 2021 report has been audited, suggesting an audit report is not an audit. The report claims Adler has triggered a default event and suggested certain questions be raised during the call on three areas: the audit, contents of the annual report and contents of the KPMG special investigations report. Two final points covered - that Covid is not responsible for development delays at Consus, and that KPMG had highlighted the company’s LTV calculation was inconsistent with prospectus requirements.

The company is looking for a clean audit for 2022, but Dr Kirsten was very clear that the Forensics investigation is “definitely closed”. With simultaneous suggestions that the company wants to remove the reasons for the disclaimer of opinion as quickly as possible, it is unclear what this means for the auditing process and parties involved. Certain withheld emails may be handed over to the auditors, Dr Kirsten suggested, as there is an ongoing process to determine what is not covered under legal privilege.

To borrow a surmising quote from Dr Kirsten: "It goes without saying that such a disclaimer of opinion is not good news. Such a note reflects a high level of distrust between the company and the auditors; but once again: we are about to make a new start, because in my opinion Adler has sufficient substance. Our existing portfolio is rock solid. The disclaimer is the confirmation of an audit that was carried out without an opinion. We have to accept that, but we will try to eliminate the reasons for the disclaimer as soon as possible. We are and remain, as I said to the special investigation, ailing but vital."

RCF default uncertainty removed

Management were asked on the call about the reference in the 2021 report to the termination of the company’s RCF facility in April 2022 and whether this constituted a cross-default on the bonds. The response was clear: “no, absolutely not”.

Initially, there was no clear answer as to which party had initiated the termination (i.e. banks or company), however Dr Kirsten appeared to receive a text during the call informing him that the RCF was indeed cancelled by Adler, thereby removing any uncertainty as to whether the facility may have been cancelled by the banks on account of an event of default. With drawings repaid on 30 December, the facility was not seen as necessary any more with more efficient ways of securing liquidity available to the company. We don’t know what these alternative means are.

Liquidity comes into focus

Dr Kirsten reiterated on the earnings call his belief that “capital markets are de facto closed to us”, meaning the company does not see it being possible to raise equity capital or unsecured debt at present. It is “legally possible” to pay a dividend and the company “definitely has the cash to do it”, but the decision is an economic one. We would be very surprised to see the company pay a dividend in 2022.

With limited scope to raise extra liquidity apart from at project level (i.e. secured debt) - a scenario that was not ruled out by management - the company laid out its liquidity scenario analysis in its presentation. At a glance, medium-term liquidity headroom looks healthy, however there are many contingencies and assumptions to consider.

As illustrated in the chart, the company’s cash balance as of the end of April was just over €700m. By year-end, this is expected to reach around €1.5bn before cash outflows, per our interpretation. On a high level, the company’s base case expectation is that liquidity coverage to end-2023 is ~1.7x.

In a worst-case scenario, in which only half of anticipated project/asset sales materialise, no new project financing is secured and payments on receivables are not secured, liquidity coverage is still sufficient at 1.17x. We caution that this worst-case coverage may be based on capex requirements alone and may not include debt servicing requirements. This is our interpretation of management remarks during the call, we welcome alternatives to this interpretation.

The inflow of funds over the rest of 2022 is contingent on assumptions around the disposal of the company’s 63% stake in BCP, the disposal of more yielding assets and the sale of more non-core development assets.

LEG Immobilien currently holds 37% of Brack Capital Partners (BCP) and a call option over the remaining 67% stake held by Adler which expires on 30 September. Adler expects the option to be exercised and has therefore reclassified the subsidiary as an asset held for sale. If you want to catch up on some background on BCP, we wrote about it here. Adler expects the total consideration for the asset to amount to ~€850m.

Secondly, the company intends to dispose of a portfolio of yielding assets at a valuation of ~€200m. It was a little unclear to us whether a letter of intent (LOI) has already been signed for this deal or whether it was expected to be signed imminently.

Recently reclassified non-core build-to-sell development assets are also on the chopping block. The company has already signed for the disposal of five projects and plans to sell another seven over the remainder of 2022. In total, expected proceeds are around €700m, however we are unclear if this is a gross or net figure (i.e. after repayment of secured/project debt).

As of the earnings call, €428m worth of deals had been signed with an estimated €542m of project disposals yet to be concluded. In total, two-thirds of the development pipeline has been reclassified as build-to-sell.

Unencumbered asset ratio breached but no covenant impact; reversal of sale impact

In terms of the asset base and KPIs, the most notable accounting move at year-end was an impairment charge against Consus goodwill of €1.1bn. Dr Kirsten remarked that he was surprised that goodwill is seen as an asset, a sentiment with which we agree. Regardless, the mark-down resulted in the unencumbered asset ratio dropping below the incurrence covenant level of 125% to 114.5%.

As the covenant is an incurrence-based covenant, Dr Kirsten stressed that it does not constitute an event of default but that it prevents the company from raising new funds. It does not restrict the refinancing of existing funds and the ratio is expected to reach a more “comfortable” level of 135% once the expected sale of the remaining BCP stake to LEG goes through.

During the Q&A session, management were asked whether the reversal of a sale of a portfolio of predominantly commercial assets to Partners Immobilien Capital Management in May 2020 would have any bearing on this incurrence covenant. To explain, Adler had only received ~40% of the purchase price for the sale of the assets at year end and, based on a lack of clarity on the payment of the remaining amount, decided to rescind or reverse the transaction.

The question was about whether possible debt held at this asset level coming back onto the balance sheet would constitute a breach of the unencumbered assets incurrence covenant as it could be seen as new debt incurrence.

Initially, management responded to say that the reversal would lower LTV, per our interpretation, and would therefore not violate covenants. There was also something said about any possible debt being non-group level, however the audio quality of the call at this point made it somewhat inaudible. Later in the call, CEO Thierry Beaudemoulin, confirmed that the asset will come back onto the balance sheet without any debt and that Adler would work to sell it again by the end of 2023.

Commitment to clarify situation with loan from Adler RE

Adler Group put out a release on 30 March, disclosing a transaction with a related party — in this case subsidiary Adler RE — in which Adler Group borrowed €265m from Adler RE. You can see in Adler Group’s annual report that the cash was received by Adler Group before year-end.

Four questions arose on this transaction during the Q&A session: i) what were the use of proceeds; ii) was any money on-lent to Consus; iii) are inter-company loans subject to incurrence based covenant tests and iv) why was there a three-to-four month delay between the cash being received and the statement being released.

Management could not confirm the use of proceeds. Management similarly could not confirm whether some of all of the money was on-lent to Consus.

Inter-company loans are not subject to incurrence-based covenants under the bond docs, per management. In response to being asked whether inter-company loans can be done now that the company’s unencumbered asset ratio is below the covenant level, Dr Kirsten replied - “I believe so”.

On the ostensible delay between the receipt of funds and the disclosure of the transaction, Dr Kirsten suggested that the loan was agreed prior to his appointment in mid-February. Closing this section of the Q&A, Dr Kirsten remarked - “we simply don’t know”. He committed to putting out a piece on this. As of the time of writing, we have not seen any release from Adler.

Holding of Aggregate bonds not good governance

“It does not even remotely resonate with my understanding of good governance” was part of Dr Kirsten’s remark in relation to Adler holding €34.2m in nominal value of Aggregate Holding bonds as of year-end. Although the transaction is “absolutely legal”, the board has decided to take away control of the holdings from management and intends to hold the bonds to maturity. If the market price of the bond improves, the board may seek to sell the bond prior to maturity.

For some quick context, Aggregate’s €600m 6.875% 2025 SUNs are currently indicated at just below 40-mid. This means market value of the €34.2m of nominal holding is only ~€13.5m. You may be familiar with our recent coverage of Aggregate Holdings (see here), but even the price alone is a clear indication of the challenges facing the recent Adler Group majority shareholder.

The middle of May has been earmarked as the point at which Adler will next update the market on its measures. Q1 results are due at the end of May.