The sporting metaphors thrown up by the Tokyo Olympics could not be more fitting for the merger process involving listed German residential giants Vonovia and Deutsche Wohnen, which – by sheer coincidence – took place around the same time as the Games.

After tripping at one of the final hurdles, frontrunner Vonovia acted swiftly to stay in the race, launching a fresh push which saw it power down the home straight towards gold.

Vonovia has not captured gold yet – in this case its takeover target Deutsche Wohnen. At the time of going to press, the outcome of a new, higher bid remained unclear. But, as with most Olympic events, when that prize is achieved, the victory will be all the sweeter for the long and hard road leading up to it.

Vonovia has been trying to take over its smaller, Berlin- focused peer since 2016. The voluntary bid mounted in May this year was the second attempt after an earlier, hostile approach failed five years ago.

This time round, it seemed as if all the signals were on green, even though a tie-up remained politically controversial against a backdrop of mounting public anger over soaring rents and lack of affordable housing, notably in Berlin. A business combination made sense strategically, to gain a stronger position in the face of political headwinds, and to better address housing supply and sustainability issues. Not unimportantly, it also had the backing of Deutsche Wohnen’s management, which was not the case back in 2016.

Prospects for a smooth transaction looked good after the proposed €18 bn offer – creating a combine with property holdings worth nearly €90 bn – was cleared by the German antitrust authorities in June and looked set to gain shareholder backing a month later. But as the 21 July deadline for tendering shares drew near, Vonovia’s management was forced to concede that it would not reach the required 50% acceptance threshold, adding that the tender period would not be extended.

But, just as the market was getting to grips with news of the collapsed deal, Vonovia announced plans for a new, sweetened offer to win over the reluctant Deutsche Wohnen shareholders who had thwarted the first bid.

Market observers say the fresh offer – which adds one euro to the initial €52 per share bid – has a good chance of succeeding. ‘It’s a done deal in our view,’ says Peter Papadakos, head of European research at real estate analytics firm Green Street. ‘They’ve learned from their mistake [with the first bid] and are not taking any chances this time round.’

Game of chicken
Papadakos says Vonovia was ‘overly confident’ of the first bid sailing across the line. In a note issued shortly after it collapsed, he wrote: ‘Overall there seems to have been a level of complacency about this deal going through that ironically led to its collapse. Since it is typical for shareholders to cast their vote at the last minute, the management and bankers seemed confident enough not to use any of the risk mitigation measures at their disposal.’

Among the dissident Deutsche Wohnen shareholders were a number of hedge funds with merger arbitrage strategies which ended up playing a ‘game of chicken’ with Vonovia, says Papadakos.

‘It was a classic game of chicken – Vonovia was waiting for arbitrage funds to tender their shares at the last minute and the hedge funds themselves were waiting for Vonovia to up its bid at the last minute. So, they were both waiting on each other, no one moved, and in the end the funds held on to their shares and Vonovia didn’t get above 50% threshold.’

Among the ‘lessons learned’ is that Vonovia has increased its stake in Deutsche Wohnen to close to 30% (from around 18% before), meaning it only needs to sway another 20% of shareholders to get to the 50% threshold. It has done this partly by buying more treasury shares from Deutsche Wohnen, which had been excluded from the deal before. Bank of America has now also been brought in alongside Morgan Stanley to help woo shareholders and secure the deal.

But despite measures to ensure maximum ‘deal security’, it remains to be seen whether the new bid, which was formally launched on 23 August, will succeed. Union Investment, one of Deutsche Wohnen’s largest shareholders with a 2.5% stake, has said the improved offer is still ‘not fair’ because it does not reflect true asset value. Union rejected Vonovia’s first bid in May.

Vonovia chief Rolf Buch stressed the latest offer is final, and that there will be no third takeover attempt at a higher price. Deutsche Wohnen shareholders have until 20 September to tender their shares. Papadakos and others say that while the €53 per share offer may be dilutive for Vonovia shareholders, it represents a ‘fair deal’ for Deutsche Wohnen shareholders with an implied 17.8% premium over the share price in May before the first offer was announced.

‘Looking at the presentations of the two companies, this looks like a fairly priced transaction and looking at the share price developments of both, that seems to confirm that,’ says Oliver Puhl, co-founder of Aventos Capital Markets, a Berlin-based investment boutique which invests globally in listed real estate companies, including Vonovia.

Both Vonovia and Deutsche Wohnen have been at pains to stress publicly that a tie-up between their firms is ‘strategically compelling’ and will bring ‘significant benefits’. The challenges on the real estate market can be shouldered better together, said Deutsche Wohnen chief Michael Zahn, noting: ‘Our impression from recent discussions with our shareholders is that they also recognise this strategic logic.’

Strategically sound
Market experts generally agree that a merger makes sense from a business and strategic point of view. A combination of the numbers 1 and 2 in the German residential investment market – both listed on the blue-chip DAX index – would create a giant of mammoth proportions, with a portfolio of 550,000 units valued at nearly €90 bn.

This would make Vonovia, as the new entity would be called, not only the market leader in Germany, but across the whole of Europe. Besides a dominant position in home market Germany, Vonovia is also active in Sweden and Austria. One of the main drivers behind the tie-up is to gain a stronger market position both in terms of delivering on affordable housing goals and addressing sustainability issues such as the switch to renewable energy.

‘There’s a bit of a tendency right now to say “big is bad”. I don’t share that view at all,’ says Puhl of Aventos. ‘Rather I would say: sometimes when you need to get things done you have to be big, because big also means that you can be more efficient.’ According to Vonovia, the merger will generate cost savings of some €105 mln ‘from the joint management and the regionally complementary portfolios’.

‘With the deeply integrated value chain that you have in residential, there are real cost efficiencies – both operational and financial – to be gained,’ Puhl says, noting that this was also apparent when Deutsche Annington took over Gagfah (the predecessor companies of what later became Vonovia) in 2015. ‘The savings were very real – and they also translate into better services for tenants.’

Besides economies of scale, ESG and sustainability goals are an important part of the merger, agrees Matti Schenk, a research associate at Savills Germany. ‘Both companies own a large amount of stock that requires extensive refurbishment. Due to the size of the combined portfolio there is massive demand for energy efficiency and modernisation, and part of the reason behind the two wanting to join forces is to rise to this challenge,’ he says.

Schenk points out that Vonovia’s recent €600 mln green bond issue also fits into these sustainability aspirations as ESG gains importance among institutional investors and on financial markets.

Political headwinds
But arguably the most ‘visible’ side to the merger is dealing with the negative publicity around the highly sensitive issue of rents and lack of affordable housing. German landlords have faced intense public pressure in the past few years over rising rents, particularly in Berlin, where the majority of Deutsche Wohnen’s 155,000 apartments are located and where 85% of residents are renters.

Residents and renters took to the streets of the German capital in angry protests in April after Germany’s constitutional court ruled that the rent cap (Mietendeckel) imposed by the Berlin state government in February 2020 was unconstitutional. Under the cap, rents for 90% of Berlin’s apartments were frozen at their June 2019 level for five years, and tenants were concerned that with its lifting they would be hit by sudden price hikes.

‘As the largest owners of rental apartments in Germany, Vonovia and Deutsche Wohnen are both in a negative spotlight of politics and action groups – they don’t have the best reputation among tenants,’ observes Schenk. ‘My assumption is they want to join forces to be stronger in the face of these political headwinds.’

Vonovia and Deutsche Wohnen have been keen to emphasise their ‘social face’. Announcing their merger plans, Deutsche Wohnen said: ‘Deutsche Wohnen and Vonovia aim to create a tenant-oriented and socially responsible housing company that can reliably contribute to necessary solutions, especially for the Berlin housing market, in close partnership with politics.’

For its part, Vonovia has pledged that it will not claw back foregone rents as a result of the court ruling and that it will reset them at levels prior to the freeze. As part of the merger deal with Deutsche Wohnen, it has also offered to sell around 20,000 apartments to the state of Berlin as part of a proposed ‘pact’ with regional politicians to help the city’s housing market. It has also said it will build some 13,000 new units and limit rent increases to 1% per year in the next three years.

Social unrest
 Whether this charm offensive will be enough to appease renters and ‘political Berlin’ remains to be seen. Vonovia and Deutsche Wohnen have another hurdle of social unrest to cross in the form of a public referendum calling for large private Berlin landlords (with more than 3,000 units) to be ‘expropriated’ and their property turned into social housing stock.

Set to take place on the same day as Germany’s federal elections on 26 September, the vote is the culmination of years of campaigning by a movement bearing the name ‘Expropriate Deutsche Wohnen & Co’. Its aim is to prevent further rent hikes by nationalising a large chunk of the city’s housing stock and placing it in the hands of a ‘democratic and transparent’ public administration agency. Recent German media reports suggest the referendum has a good chance of succeeding, although its results are not binding.

Although the campaign has grabbed news headlines and is a reputational risk to Deutsche Wohnen in particular as the main target of the activists, for business and financial markets it is no more than a sideshow. ‘I don’t see the referendum as a material fact. It’s not serving any purpose when the claimed real purpose is to create affordable space,’ says Puhl of Aventos.

He believes Vonovia can deliver on its promise of building more housing stock following takeovers of companies such as Austria’s Buwog which have brought in significant development capacity. ‘If the relevant market players could have a more constructive dialogue with politicians to really sort this out that would be perfect. But in the end you need land and you need to be able to build something on that land that will yield something for an investor,’ he says.

Is there a risk of Vonovia becoming an unwieldy giant following yet another takeover? Schenk of Savills believes not. ‘The addition of Deutsche Wohnen’s 155,000 apartments equates to about a 25% increase in Vonovia’s size so that is not a dramatic change to the structure of the company. Vonovia is already a highly professionalised platform which has built up a widespread portfolio in almost all regions in Germany so they are well equipped to manage such a diversified portfolio.’