AFI Development FY2008 Preliminary Results Conference Call 17 March 2009
Igor Solomon Hello, everyone. Welcome to our Annual Results 2008 conference call. Today, Avi Barzilay, CFO of the company, will present the financial results and the operational update, then we will open the Q&A session. Avi Barzilay Thank you, Igor, good afternoon to everybody. The presentation is on our website now, I will go through the presentation and then we’ll open to Q&A. At the end of 2008 we saw an intensification of the global economic crisis. After the first nine months of 2008, the Company recorded a substantial loss at the end of 2008, amounting to US$107.8 million. Most of the loss came from new valuation we had made for all of our properties and, as a result of this, we were down almost $200 million in Q4. In 2008 we completed a few development projects like the residential part of Ozerkovskaya, of Four Winds, and one important issue is that at the end of 2008 we have on our balance sheet US$272 million after paying $200 million as a dividend at the end of 2008. As we said in November when we published the report for Q3, the company is now focusing, through 2009, on our large-scale developments in Moscow that are now under construction, the Mall of Russia in Moscow City and Tverskaya Mall. As I said before, we finished the residential part of Ozerkovskaya and we intend to open the hotel in this project later this year. Results and financial highlights The net asset value now stands at $2.5 billion, which represents $4.82 per share, down by 60% since June and 57% since the end of 2007. The value of the company’s investment portfolio is almost $2.5 billion, down 58%. The loss for the year is more than $107 million versus profit of $215 million in 2007. The company paid an interim dividend at the beginning of December, an aggregate amount of $200 million. The company has a strong cash position, we retained 272.5 million in cash and cash equivalents as at the end of December post-dividend One important point is that starting from Q1 we will implement IFRS amendment to IAS 40. We had expected to record a profit of almost $700 million before tax, based on the current valuation. The main profit will come of course from Moscow City, but the rest will come from other assets that are now under construction. The business highlights for 2008 was the successful completion of the following projects on schedule: Four Winds, the residential building of Ozerkovskaya Phase II, the hotel and the residential and the sale of Acquamarine II, which is also part of phase II in Ozerkovskaya, office building, in May 2008 for more than US$200 million. Our share from this sale is more than US$80 million. The construction of Mall of Russia will remain on schedule, but, as everybody knows, we saw a slowdown in rental demand due to current market conditions and significant slowdown in residential sales since June 2008. As we said in November, and have repeated, we are now focusing on two projects: in the centre of Moscow, the Mall of Russia and Tverskaya. We have secured credit and the funds for these two projects. The Mall of Russia is financed by VTB and you can see in slide seven that total capex to the end of this project, which we intend to open before the end of the year, is a bit more than US$200 million and we will have $230 million in the secured fund balance to the end of the year. In Tverskaya we intend to invest, this year, more than $100 million and, by the end of the project, almost $200 million. At the same time, the secured funds balance is more than $200 million. So we are fully funded for these two very significant and very important projects.
Valuation The total value of output value based on the JLL valuation and cost is about $2.5 billion, 58% down since June, comprIsing yielding properties which is 176 million, residential properties 315, and projects under development 1.6 billion. A few projects which we define now as landbank and hotel have not been valued by JLL this time. We have explained this in our chairman’s statement. If somebody asks later, we will provide a comprehensive answer. The main reason for this is due to the situation in the market, JLL prefers not to value this project and publish a market value for this project this time. Our NAV stands at $2.53 billion or $4.82 per share, 60% down since June. The fall in NAV is driven principally by current market conditions, decrease in rental rates, selling price and increase in yields. And so you can see a substantial decrease in rental rates and a substantial increase in yields since June. We will skip the Moscow real estate market trends, but if somebody asks us later in the Q&A we will say more about this. Portfolio update, slide 11 in our presentation In Ozerkovskaya we completed phase II at the end of 2008, commissioning permits for hotel and a residential building obtained, but we sold only 46% of the residential premises and, as I said before, very few transactions have been made since June on this project. The hotel is scheduled to open later on this year. Four Winds: we completed the residential building after we completed the office building at the end of the 2007. 74% of the apartments have been sold, as I said. Office building generates a NOI of circa 31 million, of which, after development, we received 50%. The Mall of Russia, the current status it that the shell structure and the cupola are 100% complete. The internal engineering systems are almost 50% complete. 35% of the gross lettable area is pre-let at the moment with agreement accounting for 16%. We saw in the last two months a significant change in this project and we start to find, more and more, LOI and MOU agreements in January and February and, based on this, we believe that we will open the mall by the end of the year with the majority of the space let out. As I said, the mall is scheduled to open in Q4, 2009. The project is 100% financed to completion. In Tverskaya, the shopping centre, the City of Moscow agreed to finance the infrastructure, rather than compensate the company upon completion. We wait for the City to start financing it in order to resume work in the project. This project also has a Sberbank facility balance of $208 million at the end of 2008. I would like to open to Q&A at this stage.
Q&A Ekaterina Krasnenko, UBS, Moscow: Could you please explain why you put Ozerkovskaya on hold? Avi Barzilay We finished the skeleton of the project and now we will try to start marketing. When we have finished marketing we will find a client or tenant for the building, we will complete the building. The building is in the provision of a fully completed structure; there is the skeleton of the project, and we are now waiting for a tenant. Ekaterina Krasnenko So is it complete or not? Avi Barzilay No, the shell is complete. The core is complete and now we are looking for a tenant and then we will complete the building.
Ekaterina Krasnenko But earlier you said that you have secured financing for it, right? Avi Barzilay Yes, but we think there’s no point to continue to invest money, although we have the money. We can see that the market is very low these days so if you can wait, we will wait a few months and then we will see, hopefully, recovery in the market and then we will continue and complete the project. Ekaterina Krasnenko So you don’t construct anything, even if you have the money? Avi Barzilay We will find a tenant. Julia Gordeyeva, Deutsche Bank, Moscow If you could comment perhaps on the rental trends for your yielding properties, I’ve noticed that your vacancy rate is going up, but what about your rents? And also if you could comment on terms of agreements for those rents, can they be revoked, what are the penalties, etc? Avi Barzilay We can see a change in the rent price, for sure. It’s lower than in the middle of 2008. Julia Gordeyeva How much lower? Avi Barzilay It’s a good question because our spaces are not so significant and, as you can see in the list, it is a different project here. In prime location I think we can say 20% to 30%. Igor Solomon It depends on your question, if you’re asking for the general market conditions, I think you know that the prices went down by 20% or 30% at prime locations. Julia Gordeyeva I’m asking for your yielding profit. Igor Solomon Specifically for our project, Four Winds, which is the prime location project, it is within the contract that we signed. The only thing is that some of the tenants have built in hedging against the forex changes, so that is the reason that the ultimate rental stream went down by a small margin, because they were hedged against the devaluation of the rouble, with limits for some of the yielding. In other yielding properties, especially Ozerkovskaya, Four Winds, Berezhkovskaya, that we’re initially... and if we’re going to continue with this project through a development stage later on after the project is finished, those buildings will be demolished. But at this time we continue to enjoy rentals from these projects. Those rental contracts, most of them are in roubles and they are short-term for 11 months. So there we will see some 30%, 40% down in the rental trends. Julia Gordeyeva So I guess starting from 2009? Avi Barzilay Yes.
Julia Gordeyeva Coming back to a question on the Ozerkovskaya III office building, are there any conservation costs for you and what kind of rates would you be looking to market this to find a tenant, to resume construction? Avi Barzilay We don’t have a significant cost in conservation of this project. We try to market this building at $1,000 per square metre. Julia Gordeyeva And the last question, if I may, you have some committed capex for properties, including, for example, Otradnoye If these properties are not developed, what will happen to this committed capex? Avi Barzilay We will cancel the agreement. Julia Gordeyeva Are there any penalties for you cancelling these agreements? Avi Barzilay I don’t think so. Elena Mills, Alfa-Bank, Moscow I wanted to ask about your credit lines and specifically about a comment that you made in your November release with respect to the potential for some of the credit lines to perhaps be negotiated, potentially resulting in interest rate increases or a decrease in the total credit line. I know the amount of the credit lines that you’re now quoting but I’m just wondering, is there any further scope for renegotiation of the terms going forward, or are you fairly confident that the terms are going to stay where they are? Avi Barzilay In Tverskaya I think that we have the rate already, so I don’t expect any new things there but I’m not expecting to see any change on this in the coming months. In Moscow City we are negotiating now with the bank and maybe we will change some of the figures in this roubles based loan and something happened to the rouble during the last month, so we are in negotiation with the bank about this. I’m not expecting a significant change anyway. There will be change, yes. Elena Mills Thank you. And if I could also ask a follow-up question on the Mall of Russia. You mentioned in your release that about 16% of the GLA is now covered by lease agreements. I’m just wondering if you could talk a little bit about your comment that you’ve seen a bit more interest in the property in January and February. What makes you so confident that you are going to be able to open the mall with close to full occupancy? And if you could elaborate on exactly what kind of tenant interest you’re seeing, on the quality of those tenants, and maybe talk about what kind of concessions you might need to be making in order to get the building to be fully occupied by the time that you open it. Avi Barzilay The confidence, if we can say, is something confident these days, which is not the usual day. It came from the activity in January and February. As oppose to the situation in Q4, when we saw very few discussions – I’m not talking about transactions – I’m talking about discussions with tenants. In January and February we can see tenancy discussion and we start to sign with tenants for the mall. Based on the discussion that we have now with a lot of tenants, out of these, agreements we have circa 35%, we believe that we can conclude a significant amount of agreements and to lease out a significant space in this project so we will be in the position to open it in Q4. We are not talking now about fully let in Q4, but we’re talking about the majority of the project will be agreements and then we will open in Q4. I don’t think we can find ourselves with 100% pre-lease but we are targeting to be 70% to 80% today.
Igor Solomon About the concessions, we’re ready to grant the tenants clauses starting with a reduction of the deposits down to a reduced rate in the first year with a step-up in the second and third year, or some combination of a low base rent and mainly the turnover percentage in the first or maybe even the second year. Elena Mills Thank you, that’s very helpful. And are you finding generally that the quality of the tenants for the Mall of Russia is consistent with what you would have expected at this time, or are you seeing any sort of shift in terms of tenant profile? Who specifically is expressing interest in the location now that perhaps may not have been interested earlier? Igor Solomon No, it’s the same profile. Different names perhaps, but it’s the same profile. Elena Mills Thanks very much. Julia Gordeyeva Can you comment on cap rates that were used in JLL’s valuation and whether you see any, I guess, devaluating with them recently, so if you see any movement in cap rates one way or another, if you see any more interest in the properties? Avi Barzilay From where? I mean, we saw JLL’s final valuation a few days ago. This number is based on a completely different set of assumptions, especially concerning the yields of the project, the cap rate. They increased the cap rate in the project very sharply from June and September to December. We can find ourselves with a project in prime location in Moscow, like Four Winds, they want 11%, and a project out of the centre even close to 15. I think this is the situation today. I don’t think any dramatic change from the end of December or actually from the last week until today. Our next financial report will be in May for Q1 and we will make a review again. I don’t say that we will make new valuation, but will have new discussions. We will discuss with JLL what the situation in the market is and then we will take a decision if we want to update some of the valuation again in May. But if you ask me today, I don’t think so; I don’t think we will see a dramatic change between today and May when we will publish the Q1 report. Julia Gordeyeva Of all the purchases that you made in 2008, are there any remaining payments left? Avi Barzilay Nothing special, no.
Elena Jouronova, JP Morgan, Moscow I was just wondering about your views on the property market in general. Do you think that we have seen the worst already, or is it yet to come? Avi Barzilay Who knows? Hopefully the worst is behind, but we don’t know. We live in a very unique situation, very unique economic situation in the world, so hopefully we will see better days soon, sooner than later. But I think this is your job; you’re the analyst
Elena Jouronova Are you, as a property company, seeing any signs of more visits to your properties, more interest from potential tenants? Avi Barzilay The answer is yes, we can see significant changes in general, for February versus Q1 in the sense that in Q4 nobody came to the office. I mean nobody came to the selling office, nobody. We had no serious discussion with tenants about our project and, in general, we can see the tenants again, we can see the buyers again. Yet we’re talking about completely different prices, so it’s improvement if you want to compare it to Q4, where the market was a complete freeze. Today we can see people, we can see markets. But we’re talking today about completely different prices, very low prices, if you were to compare it to mid-2008. So the message is very optimistic. But yet we are far, far away from the situation we stood in mid-2008. Elena Jouronova Because I guess that if you expect to open Mall of Russia in Q4 and to lease it, to have it 70% or 80% occupied, whereas now you have only 16% of GLA cover with pre-lease agreements. That would imply that your side of the market is really recovering and the recovery is quite significant in spots. Avi Barzilay We are not having discussions about our lack of space in the mall. We are covering more than 35%, which we have mentioned in the report and in the signed papers. We have discussion and negotiations about the majority of the space in the mall. The fact is that we believe that the tenants want to close a deal, they want to be in our mall and we want to close the transaction before the opening, this has led me to the optimistic conclusion that we will open the mall before the end of the year. Elena Jouronova And do you think that this would require you to further reduce the average rent from the figure you mentioned in the press release, 1,150? Avi Barzilay Yes, on average. Elena Jouronova You would have to go down further, yes? Avi Barzilay No, I don’t think so. Look, we’re talking about 50% down from the numbers we talked about last August. So this change that we made in the price was due to the situation. We believe that this is enough but let’s see. Elena Jouronova In the press release you mentioned about the new IFRS that you would implement for your financial reporting and you’re saying that you can record the process of about $680 million. Can you please explain this a bit more? Avi Barzilay Yes. Since today, according to the IFRS, we value on our books and our balance sheet only investment properties, meaning projects that we’ve already finished and are let. Since the beginning of 2009, meaning the first quarter, Q1, according to the IFRS we need to evaluate also investment properties under development or under construction, like Moscow City, for example. And the difference between the costs of this project, Moscow City, for example, which is between $200 million and $250 million cost at the moment to the end of the year. If you compare it to the market value of the project which is $740 million, so all the difference, around $500 million, is again, according to the IFRS. This will be recognised as a gain for the first time in Q1.
And then we will analyse every quarter what is the value of this project, the investment project under construction, like we do with the investment properties still today. This is a new rule according to the IFRS and I know that some companies adopted this rule from this 2008 report, the annual report for 2008. Our group policy is to adopt and to implement this rule only from Q1, 2009. Elena Mills, Alfa-Bank, Moscow Just a couple of clarification questions. You mentioned that the City of Moscow has now agreed to basically fund the infrastructure around Tverskaya Zastava and that you are waiting for the City to secute financing in order to proceed with that project, basically, the work on it. Can you talk a little bit about how much this is expected to cost and when you expect the City to have the financing in place so that you can move forward? Igor Solomon Basically there is no or little news about this. If you remember from the beginning, and at better times, we took on ourselves to finance the infrastructure component of this project, meaning the traffic interchange and the utility lines which is normally under the resolution of the Moscow Government is the duty of the City with the understanding, and the resolution backing it, that we will be compensated at the end of the quarter. And now given the situation and as soon as the crisis started, from the cashflow point of view we found it appropriate to renegotiate it with the City and that’s what we see during Q4. The result you see is in our statement today. As you see in the timetable, it is not a matter of securing the finance, it’s rather the City, the municipal bureaucracy to start transferring the funds. We expect it to be a matter of several weeks. Elena Mills Am I correct in assuming that the management of the actual construction of the interchange and the utilities is still going to be undertaken by AFI or is that also transferred to the City? Igor Solomon No, that’s correct. Elena Mills So it’s just purely a cashflow issue. Igor Solomon It’s a cashflow issue, yes. Elena Mills And I’m just wondering if you might also clarify whether most of the interest that you’re seeing in the Mall of Russia relates to rental agreements in roubles or US Dollars? Are retailers mostly looking to secure rents in local currency at this stage? Avi Barzilay This is part of the negotiations that we have with our tenants today. It’s true that this was one of the questions that the tenants raised. If in the past all the payment was in the dollar or Euro or combination, the units that we are using in Russia, today more and more tenants are asking to pay in roubles and this is part of the negotiation. From time to time we’ll make a compromise about this. Elena Mills So you would still expect the bulk of the net operating income to be in dollars? Avi Barzilay I believe that we will agree with part of the tenants, not all of them, but with part of the tenants we will agree that part of the fee, or part of the rent, will come in roubles.
Elena Mills With respect to Ozerkovskaya, what are you prepared to do, or how are you thinking about the residential sale process now? Is it your opinion that you just want to wait this downturn out and not really agree to offer substantial discounts, waiting until the demand comes back? Or are you now in a position where you feel like you want to start to perhaps stimulating demand a bit by offering bigger discounts on these apartments? Avi Barzilay We see interest of buyers in the project today. Obviously the price, there’s a substantial discount if you compare the number to mid-2008. We’re talking today about less than $10,000 per square metre or around this number. But it depends on the apartment; it depends what is the case by case apartment, what is the flow, etc. The site is ready and we’ve finished the construction; we are not under pressure. We don’t need to generate cash immediately so we can sell it as very high-end apartments, very unique apartments and we will sell them during the year hopefully. Elena Mills And any update on Kuntsevo, the permit process there and any of the other paperwork that you’re involved in now with resurfacing land banking projects? Igor Solomon We’re making progress on all of them. For example, for the plazas, hopefully the paperwork will be easier to pursue and to get the final zoning on that. In Kuntsevo we’ve made some minor acquisitions on either side. As you know, we increased dramatically the land slot that was designated for this site earlier in 2008 and now we are working on the approval of architectural concepts for that. And, as we explained, it does not require substantial capex; it’s just a matter of several millions of dollars as opposed to tens or hundreds of millions at this stage, and it does not require huge project management theme. It’s really the core competence of the CEO and the team that specialises in the land’s rights and registration and so on, and the full development process. And we’re on track with that but obviously we’re not in a hurry. Julia Gordeyeva, Deutsche Bank, Moscow I wanted to follow up on Elena’s question on Mall of Russia. How are your tenants taking your step-up, the 30% and 20% step-up? Are there significant objections to that or are the tenants pretty much seeing recovery beyond 2011, I guess, and so not treating this badly? And also I suppose that the currency is the same as the rent for these step-ups. Avi Barzilay I think you cannot say something about all the tenants. It’s case by case. Every tenant is different and I think that all of the tenants, we are updating the business plan today based on the situation in the market. Everybody knows the situation in 2009 will be different compared to 2008. Hopefully it will be completely different if we compare it to 2010. And I see that the business terms are based on each tenant, his sector, it’s different you cannot say just for one. Igor Solomon We cannot generalise. It’s a total part of the negotiation tactics that we have. Of course the retailers today are trying, and successfully trying, to use the current market conditions also for their advantage. So we cannot say something general. But obviously those who have signed the deal are ready to chat. Julia Gordeyeva But you would be willing to consider without those step-ups? Avi Barzilay We prefer not to. We don’t want to start the negotiation here (on the call) with the tenant.
Julia Gordeyeva Fair enough. And other question that I wanted to ask on Tverzskaya Zastava, what is the total outspending liability of the City of Moscow to do it at this point? Avi Barzilay At the moment I think it’s some dozens of millions. We didn’t calculate exactly the numbers; we are working with the City to calculate the exact number, but the total project is more than $100 million. I mean the total amount of all the infrastructure is worth more than $100 million. Julia Gordeyeva Can you foresee a situation where the City will not agree to the bills that you provide for them? Avi Barzilay I don’t think so. We worked together with the City from day one and they know everything that’s going on in the project, so we don’t expect any surprises in this. Igor Solomon We also work in a similar scheme in the concert hall so we don’t expect any surprises there. Julia Gordeyeva Okay. And the payments will now be made by the City for the infrastructure. Do you expect any delays in the project overall just because the City’s bureaucracy, etc? Igor Solomon At this stage, possibly, it’s hard to say, especially under these conditions, that it is part of the commercial enterprIse and the municipality, it’s really hard to say. Julia Gordeyeva Thank you very much. Elena Mills, Alfa-Bank, Moscow Just one final question with respect to financing. Will you be required to refinance the credit lines currently outstanding with respect to the Mall of Russia, Tverzskaya Zastava projects upon completion? Avi Barzilay What do you mean require? We want to do it obviously. The credit line in Moscow City, the current credit line in Moscow City is until 2011. Obviously, before this, we will negotiate with the bank or maybe with other banks still to refinance the project, of course, with connection to the value of the project. At the moment they are financing the cost of the project and obviously we will try to refinance the project with a nice ratio to the value of the project, which is more than double to the cost of the project. Elena Mills And you’re already having discussions about this now? Avi Barzilay No. It’s too early. First of all, it’s too early and, secondly, the situation in the market, I don’t think it’s the best day to try to start negotiation about something like this Elena Mills So we should assume that the 2011 credit line stays in place until 2011? Avi Barzilay Hopefully, if the situation changes next year in 2010, we will start negotiations next year. But anyway all the banks will ask for a period of stabilisation in the project after the opening, so anyway we’re talking not before the second half of 2010.
Igor Solomon Thank you very much for your participation in our Annual 2008 Results conference call. You will be able to download all the materials from our website and also from the RNS and of course you know that we are always at your disposal with any questions you might have. Thank you.