Friday, November 30, 2018

Northstar Realty Europe: CLNY Out, Reviewing Strategic Alternatives

Northstar Realty Europe (NRE) is kind of an odd duck, it's a U.S. listed REIT that is externally managed and only owns assets as the name would suggest in Europe.  Specifically, NRE owns 23 buildings, primarily Class A office buildings in Germany, France and the United Kingdom.  There are plenty of European listed REITs that own European assets and U.S. listed REITs that own U.S. assets, so it's hard to see the logic in having one that crosses the two.

In 2014, the old Northstar Realty Finance (NRF) spun off their management company, Northstar Asset Management (NSAM), which was a popular move at the time, hoping to create a permanent capital asset manager that would trade at a high multiple.  After the initial spin, NSAM wanted to create several externally managed vehicles to generate fees, thus NRE was formed via a second spinoff from NRF in November 2015.  This model ultimately failed because the market rightly valued the externally managed REITs at a substantial discount to NAV preventing the manager from growing their fee revenue streams.  Only a few months later, in June 2016, NSAM and NRF entered into a complicated merger with Colony Capital (CLNY) without NRE that ended up orphaning the REIT and left it to continue to trade below NAV with the new Colony as the manager.

Between the NSAM/NRF/CLNY merger and a few weeks ago, the company slimmed down their portfolio from a grab bag of sectors and countries down to something more streamlined, repurchased $83.4 million of shares well below NAV, restructured the management agreement to be more favorable to shareholders, and some activists got involved (read the Senvest letter here) pushing the company to liquidate or sell itself.  

I know what you're probably thinking, this sounds a lot like NYRT did prior to the liquidation and didn't that blow up?  Painful memory!  But hold onto that thought.

In early November two important events happened that make this situation particularly interesting today:
  1. NRE sold their largest asset, Trianon Tower in Frankfurt, for approximately $762MM.  Trianon makes up 37% of their published NAV and NRE expects to net $360MM after paying off the property level mortgage and transaction costs.
  2. NRE announced a process to review strategic alternatives and more importantly reached an agreement with Colony to terminate the external management agreement for $70MM effective upon the consummation of a sale of NRE or if there's no sale, an internalization of management.
Today it trades for approximately $16 per share with 50.1 million shares outstanding for a $800MM market cap.  After the sale of Trianon closes, NRE will have $425MM in cash (there was $65MM as of 9/30), then subtracting out the $70MM owed to Colony, and NRE will be sitting on roughly $7 per share in cash.

European REITs publish an NAV in accordance with the European Public Real Estate Association's (EPRA) best practices guidelines, think a trade association similar to NAREITs guidelines around AFFO and FFO standardization.  NRE's published NAV utilizing a third party firm was $20.85 as of 9/30 (likely down slighly due to currency movements) or about $19.40 after subtracting out the termination fee due to Colony.  We can gain a little comfort in the NAV calculation in a few different ways: 1) Trianon, again their largest asset by far, sold inline with the NAV valuation; 2) over the past several years NRE has been selling assets and on average they've been above the stated NAV at the time; 3) it's performed by an independent party in Cushman & Wakefield.

Here's a sample of a REITs located in NRE's markets that report EPRA NAVs and their current premiums/discounts:
I don't necessarily expect NRE to be taken over by a public REIT, but I gain some additional comfort in that most of larger office REITs in Europe trade within a reasonable range of their reported NAV.  On the flip side, NAV is used as the fee basis for CLNY's management fee so there's some incentive to goose it a bit and shouldn't be fully relied upon.

So unlike NYRT, where the largest three components of the asset value (1WW Plaza, Viceroy Hotel, and 1440 Broadway) all had some hair on them, needed repositioning or were underperforming.  NRE's portfolio has now been substantially de-risked with the Trianon sale, the next largest asset has a book value of approximately $170MM, meaning substantially smaller chunks remain.  The portfolio is also 97% leased, a weighted average lease life of over 6 years and we have reasonable debt levels with $7 per share in cash.  NYRT also paid out a dividend that wasn't covered (typical of an external REIT) that limited their ability to reinvest in their properties, NRE's dividend policy has always been reasonable allowing them to make improvements to drive leasing and rent growth activities.  NRE's downfall was more the initial management contract that stalled growth and permanently assigned a discount to the shares than the performance/management of the underlying assets which was solid.

I don't see internalization of management as a real alternative, the company is simply too small to make it a viable path forward, the likely outcome now that Colony is out of the way is a sale of the company in pieces or preferably in its entirety.  There's probably $2.50-3.00 of upside on a $16+ stock in the next 3-6 months.

Disclosure: I own shares of NRE

5 comments:

  1. Hi, thank you for sharing this idea. Between your post and the near simultaneous write up by Yet Another Value Blog, I have learned a lot. Would you say it is more likely that NRE is bought out completely, or sold off in pieces? I would assume management is aiming for an outright sale to one bidder, as it would be faster and cleaner.

    I was also wondering if you would provide an update on STAR? I know that this is one of your larger holdings. After cutting through the complexity, SOTP suggests a very large gap between trading price and IV, even when factoring in some interest rate headwinds. If nothing else, SAFE looks like an interesting move. Thank you in advance.

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    1. I agree that an outright sale is preferable.

      On STAR - I've soured a bit on it and may consider trimming or jettisoning it completely. You're right, there appears to a big gap between the trading price and intrinsic value but I've lost confidence in Jay Sugarman's desire to close it. You mention SAFE, it seems more like a distraction or a second chance at glory for Jay, he's out there promoting the shares (to be fair, he needs to in order to grow it) when its a fairly insignificant asset for STAR. I also worry a little bit about the CRE finance book, a lot of those loans are construction and development loans to high rise condos in cities like NYC where the market is softening. We saw what the market did to OZK. The dividend was smaller than I expected and didn't create much of a catalyst. If one wants to own undervalued land/development assets and undervalued net lease assets, probably pairing something like HHC and SRC together will generate better results, have more confidence in those management teams compared to STAR.

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    2. The credit rating upgrade a few days ago struck me as a potential forward catalyst for the stock price, as they enjoy the benefits of a lower cost of capital, which then materializes favorably in future operations. The dividend yield is nothing to get excited about but at least it "normalized them" a bit and gives them a logical base of investors (dividend investors/retirees/etc.) With a low payout ratio, it looks highly likely to be grown steadily.

      I understand your position on SAFE, although it does seem to be gaining traction with the targeted audience, with several recent Seeking Alpha write-ups from some widely followed contributors (admittedly not all bullish). Visibility for/excitement over SAFE also draws attention to STAR and it's cheapness. If there is truly a $500 billion market for ground lease as Jay stated, SAFE's management fees to STAR could end up being a pretty significant asset for them down the road.

      Your point on NYC construction loan exposure is well taken- I know enough about OZK to give it a wide berth. Wildly aggressive bank = bull in the china shop!

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    3. The right thing to do is to simplify STAR into what it looked like pre-crisis, a credit REIT. Sugarman deserves some credit for navigating them through the crisis, essentially surviving, but its been 10 years now, the path forward should be pretty obvious but for some reason they're not doing it. They don't want to be a vanilla REIT, it would be one thing if it traded at a premium, but they don't have that luxury when it trades at such a discount. Maybe the value discount isn't really there (their disclosures could use some work) or maybe its just an incentive problem, being a developer is sexier, lending to prominent condo projects probably results in invites to fun parties, etc. Its been a few years of "reduce G&A" talk, never really happens, instead we hire additional C-Suite executives. An activist would help here, there's no controlling shareholder, someone could really create their own catalyst.

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    4. All fair points, and I agree with you that the situation is ripe for an activist- lots of levers they could pull to generate big profits here. Hopefully someone will step up to the plate.

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