Tuesday, March 6, 2018

Spirit MTA REIT: Form 10 Notes

Some of this will be a rehash of my other post on Spirit Realty Capital (SRC) from January, but today SRC released the Form 10-12 for their spinoff, Spirit MTA REIT (SMTA), its a fun structure that deserves a little more fleshing out as it could result in an interesting investment opportunity once it starts trading in the second quarter.

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


  1. Hi, great blog, the best I have found to date. I am also long SRC. I was wondering if you would post on your experience with call options when it comes to spinoffs. I have never invested in options but I can see why there might be opportunity here, similar to Greenblatts eg of Marriott International and Host Marriott in YCBASMG. People will be waiting to buy SRC, SMTA is highly leveraged and will be small compared to SRC. Of course options are risky so only a small % of portfolio should be invested in them. Do you typically invest in options that are weeks or months in the future? What has been your success rate? Any thoughts on SRC options? Thanks in advance.

    1. Thanks for the kind words, sure a few thoughts:

      1) Here I expect the spinoff to "force" the market to put some value on SMTA where its seemingly putting very little value on the Shopko assets today. SMTA can't trade below $0. The event helps put some box around the timing issue with options, doesn't always, but it helps me mentally pick an expiration date (here I own $8 July calls). From the sounds of it, the company is still expecting an early second quarter spin date, that gives the market a month or two to re-value SRC/SMTA somewhat before my options expire. I expect the full re-valuation at SRC to take longer as they'll need to restart their lease acquisition engine and grow FFO before the market gives them too much credit.

      2) Maybe I was a little hasty, my cost basis in SRC is around $8.50 and when it fell with the recent move in rates I wanted to average down. But I also like the SMTA spin more than most I'm assuming, it's going to be a small piece of the total, so my current thought is if my calls are in the money at expiration, I'll sell down the SRC side of the spin and keep the SMTA, use the calls as almost a way to get more of SMTA "for free" now. Some mental accounting there, but its worked for me in the past. Most of the time I don't use options around spinoffs, but I'm usually successful when I do, "maybe" its because classic options pricing models usually use backwards looking volatility to price the options today, not taking into account the event that will cause significant volatility in the future? That's the best I can come up with, especially for relatively small companies like SRC that don't have significant options volume.

    2. Thanks for the quick response

  2. What is your opinion on DDR? It has the same dynamic where they are spinning the "bad assets" away from the company. The market completely wrote off the "bad assets" that is worth at least something.

    1. I haven't looked at it enough to comment, its near the top of my list to research as I know the purpose of the spinoff is similar to SRC. I'll come back if I have anything useful to say, thanks.

  3. MDC -- I enjoy your thought process. As the largest component of SMTA, do you have any more tangible valuation barometers for a publicly traded master trust? Private trades might prove a helpful yardstick, too -- I haven't come across much of either.

    1. A master trust is just a funding mechanism, STORE Capital for instance uses master trusts extensively in their capital structure as well, so its not a unique structure to SRC/SMTA. But because all the leases are put into an SPV, they're able to get more financing at better terms than they could in an unsecured offering. I wouldn't get too hung up on changing any valuation techniques because the assets are inside a master trust. Thanks and hope this helps a bit.