As a refresh, SRC is a triple net lease REIT primarily focused on single tenant retailers that needs to rid itself of its largest and most troubled tenant, Shopko, in order to increase its valuation to the point where it can raise capital again (a must for any REIT). SRC is hoping to accomplish this by spinning off its Shopko properties (and other workout assets) into SMTA but this would only work if SRC could receive proceeds in return -- here's where their securitization vehicle, Master Trust 2014, comes into play. Master Trust 2014 is an SPV that houses many of SRC's small-to-middle market tenants that are unrated (but not Shopko or the other workout assets), and uses the SPV to obtained financing secured by the leases pledged to the SPV. By putting the leases in the SPV, Spirit is able to obtain favorable financing terms such as being able to leverage the SPV up to 75% loan-to-value. As the Master Trust has amortized over the last few years, the SPV had become overcollateralized, by putting the Master Trust with the spinoff, Spirit was able to put additional debt on SMTA and return it to SRC, in essence they're able to effectively "sell" the Shopko/workout assets by spinning it off with a cash out refinancing of the Master Trust SPV. Of course they could have done the cash out refinancing of Master Trust 2014 anyway, but that would have increased SRC's leverage ratio and likely wouldn't have made their equity valuation any higher with Shopko stuck at the top of their rent roll. But by positioning the spinoff as a highly levered REIT, they're able to rid themselves of Shopko and receive precious dry powder in return.
SMTA's mission statement per the Form 10:
The basic strategy will be to sell off or redevelop the Shopko assets and put the cash/collateral into Master Trust 2014, issue notes against it at 75% LTV and run a very leveraged REIT that looks more like a mREIT or CDO structure of yesteryear. Coming out of the spinoff, SMTA will be leveraged 9.2x, but if all goes as planned, the leverage will climb significantly as Shopko makes up 20% of contractual rent and all of those properties are unencumbered. As these assets are sold, the leverage will increase substantially to something like 12x EBITDA at the end state, or about double any traditional net lease REIT.
SRC mentioned on their recent earnings call that SMTA would have a very high payout ratio, I take this to mean it'll likely be at or above FFO, here's a little back of the envelope calculation of where cash available for distribution could be before any non-cash charges like impairments or loan loss reserves.
Please alert me if there are errors, likely I've made a few, but I think it's directionally right, and then below is the potential accretion if SMTA sells their Shopko/workout portfolio at various levels of their stated "Real Estate Investment Value" of $646MM per the Form 10.
|*Revised from the original, I only had the debt proceeds and not the cash sale proceeds being reinvested originally.|
A couple other points worth highlighting:
- Some feedback I heard on my comparison of SRC to STOR was "well, STORE Capital's secret sauce is they get unit level financials and run their own internal ratings to monitor their tenants", the tenants in Master Trust 2014 are the same, 98% provide unit level financials and SRC utilizes Moody's to provide shadow ratings on all their borrowers. I contend this is a commoditized industry and there is very little secret sauce or competitive advantage, other than the "shares are really your product" marketing to equity investors concept and lowering their cost of capital.
- Fraudulent conveyance was also brought up, but in this structure the secured lenders in the Master Trust and one CMBS asset aren't being impacted by the spinoff directly, their notes are secured by the pools of leases in each SPV. Even if Shopko went bust immediately after the spinoff, the debt holders of both SPVs wouldn't be impacted. Which isn't to say the equity of SMTA being worth zero isn't a risk, clearly a recession or continued weakness in traditional retail (40% of SMTA's rent, 50% of that 40% is Shopko) will eat away at the equity strip of the SPVs and the value of the workout assets.
- SRC will be the external manager, they're charging a flat $20MM plus a promote in the out years, $20MM works out to be about 2% of the equity NAV they laid out in their Path Forward III presentation slide below. Not fantastic, but it is fixed, so as SMTA moves along in its recycling program the base management fee will remain the same providing some operational leverage (of course could go the other way too).
- SRC and SMTA will have overlapping investment strategies, high level SRC wants to pursue the more investment grade rated tenants and SMTA will focus on the smaller non-rated tenants, but I'm sure there will be times when SRC has to decide which portfolio a prospective investment should go and it likely won't often be advantageous to SMTA.
- SRC's recent $35MM term loan to Shopko will be "contributed" to the spinoff, it's included in their workout portfolio numbers, the coupon is 12% and is very likely to end up in some kind of restructuring before it matures in 2020.
Here's the old sum-of-the parts slide, I think the only changes are in the workout portfolio bucket, SRC must have contributed additional properties as the value moved to $646MM in the Form 10 versus $477MM below.
Using the new workout number, the NAV should be $3.05/share, it won't trade there but I think it's an important reference point. If my CAD number is correct, and SMTA trades like one of the ugly Class B/C mall REITs with a 15+% dividend yield, then the shares could be worth $1.50 per share of SRC. $1.50 is also about the value of the equity strip in the Master Trust SPV, as part of the refinancing, the collateral was reappraised and presumably the debt holders and rating agencies signed off on the new market value. Certainly not something to be given too much faith, but another reference point. I expect SMTA to be incredibly volatile those first few days of trading as many of SRC's traditional retail shareholders are likely to dump the stock, keep it on your watchlist!
Disclosure: I own shares and call options on SRC