Gramercy completed the sale of their CDO management business, Gramercy Finance, on Monday for $9.9 million, plus they sold their senior CDO bonds they had repurchased for $34.4 million, and will eventually recoup servicing advances of $14 over the course of the next year, freeing up a total of $58.3 million to invest in net leased assets. Best of all, they will be able to de-consolidate the CDOs on the balance sheet, making the company much easier to understand.
They also retained the equity, which they curiously put at a value of $25 million by 2018. Being quite familiar with CDOs, I know how difficult they are to value and what level of assumptions are necessary even if you have all the relevant information at your fingertips. Since these are very junior/highly leveraged tranches, the $25 million number seems reasonable if real estate values continue to pick up, although I wouldn't include it in any valuation estimate of the company, more think of it as a free option with huge upside. The 2005 CDO has the best chance, followed by the 2006 CDO, and the 2007 CDO is long gone with no value. One concern regarding retention of the equity, is the potential for "phantom income", they disclosed the risk in their 10-K. I'm not familiar with the tax accounting rules behind it, but this could represent a major issue if Gramercy was forced to make a dividend distribution (probably would be in stock?) to holders even if the company didn't receive any cash flow, big problem for those of us holding Gramercy in a taxable account.
Current Portfolio and Updated Valuation
Gramercy continues to be active in deploying their dry powder, put at $154 million by management on the call. That includes $104 million of cash, $43 million of borrowing capacity on unencumbered assets (so properties without a mortgage), $15 million coming from the CDO servicing advances, and $20 million from additional non-core asset sales. The recently announced the purchase of a property outside of Memphis that's used a distribution center for retailer Five Below. Below is the current short term pipeline, seemingly attractive assets.
So what's the company worth now? Well Gramercy gave a peek into what the future cash flows could look like, the current assets have a projected annual net operating income of $20 million. If all the dry powder was deployed, Gramercy would receive an additional $26-29 million in net operating income, lets use the low number, so the total NOI would be $46 million annually. Add in $10 million from the asset management contracts for the KBS portfolio and the Bank of America JV (for simplicity, I'm going to net out the expenses against incentive income). Total NOI projects out to $56 million. At that point, debt is projected to be $346 million, using a 4% interest rate (Gramercy previously put financing at 3-4.75%), that comes out to $13.88 million of interest expense. New core MG&A run rate has been reduced down to $13 million annually, and sounds like it could move lower as Gramercy ramps up and is no longer in growth mode. Finally, subtract the preferred dividend (the dry powder number assumed the preferred dividend was caught up) of $7.16 million, and you get total expenses of $34.04 million. Adjusted Funds From Operations would then equal $21.96 million, or $0.36 per share. Pretty close to the $0.40 I originally came up with in my first post.
Put an implied capitalization rate of 7% (or an AFFO multiple of ~14x) on the AFFO, and that puts Gramercy's potential price target at $5.17 per share, leaving some more running room. Management also stated on the call how "favorable" valuations are right now for REITs, which I agree with, so hopefully they take advantage, deploy the cash as quickly as possible, return to REIT dividend normalcy, and potentially issue equity at a high multiple. At that point I'll probably look to sell as traditional REIT investors rush in, but it's probably another year off.
Disclosure: I own shares of GKK/GPT