Friday, September 18, 2020

Marchex: Joint Tender Offer

Marchex (MCHX) is a small (~$80MM market cap) software company that has gone through a few iterations over the years, now they're focused on call and text analytics, basically trying to capture data on customer interaction to increase sales and improved customer satisfaction.

On 8/31, Marchex and Edenbrook Capital (which owns 19.5% of MCHX) formally launched a 50/50 joint tender offer that expires on 10/7 to acquire up to 10 million class B shares (approximately 25% of the publicly traded B shares), the tender is slightly unique in that it has a tiered payment structure.  If less than 6 million shares are tendered, Marchex and Edenbrook will pay $1.80/share, if between 6 million and 10 million shares are tendered, the price will be $1.96/share.  Above 10 million shares tendered and you'll be pro-rated, but with the shares trading at the lower bound $1.80, it seems like the market is saying that less than 6 million shares will be tendered.

The company has a lot of cash in relation to their market cap, $46.8MM as of 6/30, they did get a $5.3MM PPP loan, so depending how you want to account for that, the enterprise value is roughly $40MM.  They've made several acquisitions in the last few years to bolster their call analytics business that total up to more than that, either some poor capital allocation or the market is missing the transformation.  To highlight that core call analytics business, in parallel with the tender offer the company is selling their legacy business to management in a complicated transaction, it certainly looks a little strange and isn't arms length, but they've tried to unsuccessfully sell it for a couple years now and is essentially a quickly melting ice cube.  It's an attempt to remove the bad business that might be hiding a good business.

Edenbrook clearly thinks there is value here, from their initial letter to the board highlighting the undervaluation:
We believe Marchex’s trading price of $2.63 per share (as of December 21, 2018) demonstrates a substantial discount to comparable industry valuations. Similar analytics-based public companies are trading at 4-6 times revenue, while private companies are being financed at 6-10+ times revenue. If Marchex were valued at 3 times analytics revenue (which is still a substantial discount to the market and less than Marchex just paid for Callcap), and approximately $44 million in cash were factored in, this would yield a value today of approximately $4.65 per share, which is 75% above today’s trading price of $2.63 per share (as of December 21, 2018). Adding in discounted values for the legacy business and the NOL carryforward would yield another approximately $1.60 per share, totaling approximately $6.25 per share, more than double today’s price. Further, given the continued profitable growth of the business, we expect these values to continue to expand in the coming years.
The business doesn't quite click for me, but clearly Edenbrook wants more of the asset (if fully subscribed they'll increase their stake from 11.50% to 36.67%) even though this is a dual share class structure with management owning the super-voting Class A shares.  Edenbrook isn't the only one, another investor has opined publicly, Harbet Discovery Fund (owns 6.4% of MCHX):

After years of investment in the analytics products and platform, which we estimate exceeded $150 million, the Reporting Persons look forward to breakout sales growth in 2020. As the Issuer’s management team mentioned on the last earnings call, early momentum with the Sales Edge Rescue product and the expected expansion into a key OEM client could each independently drive material growth. With accelerating growth, the Reporting Persons can see a path to the Issuer’s stock trading over $5.75 per share (+186% upside from current levels), assuming 10% analytics sales growth in FY20, a 4x sales multiple on that business, and stable cash balance. Over the next twelve months, higher valuations could be reached if the market begins to ascribe the value of the marketplaces business and data library.


Absent a significant increase in growth in 2020 in the analytics business, the Reporting Persons anticipate the Issuer may consider a broad range of strategic options to maximize the value of its business units, balance sheet, intellectual property, and data library. Conversely, with rapid growth in the analytics business and the gross margin expansion that should accompany it, the Reporting Persons wonder if the analytics business will ultimately receive the maximal value as a standalone company, and also anticipate the company taking measures to simplify its structure and streamline its model over time. The Reporting Persons also expect the Issuer’s long-term track record of returning capital to shareholders through buybacks and special dividends to persist for the foreseeable future.

So the stock might be worth looking at post tender, some of these large tenders can attach the stock price to the offering price and then afterwards the stock takes off.  I'm not comfortable enough with the business to take that view but either way it makes me a little more comfortable if the tender is oversubscribed and I end up with some orphaned shares.  Edenbrook and management aren't tendering, Harbet Discovery is likely not tendering, so there may be limited shares participating if other institutional shareholders also sit it out.  In the more likely scenario and less than 6 million shares tender, I get my money back and just lose some opportunity cost, for it to work out perfectly and get the $1.96, it is a bit of a thread the needle proposition, but I don't see much risk in attempting it.

Disclosure: I own shares of MCHX

Lubys: Asset Heavy Restaurant Business Opts for Liquidation

Luby's (LUB) is a small restaurant business based out of Houston, TX.  Currently, they operate two restaurant chains (previously a third, Jimmy Buffett themed "Cheeseburger in Paradise", all of which are now closed), the namesake "Luby's Cafeteria", a Texas comfort food buffet chain and "Fuddruckers", a fast casual burger concept that is partially franchised but has seen better days.  Luby's also has a contract food service business that caters their cafeteria style menu to hospitals, senior housing facilities, sports arenas, etc.  Luby's has struggled as their concepts are a bit stale (maybe that's being kind), mature, and operate in hyper competitive market segments like Fuddruckers with burgers.  Luby's has been treading water for several years -- management has reshuffled some senior leaders and fought off a proxy contest (from Jeff Gramm, author of Dear Chairman), but none of the turnaround plans really came to fruition.  Then of course, covid hit and suddenly going out to a buffet/cafeteria style restaurant like the namesake Luby's sounds pretty unappealing or simply impossible due to local shutdowns.

Last year, Luby's commenced an effort to explore strategic alternatives, but on September 8th the company kicked up the effort by formally announcing they were pursuing a liquidation (requiring shareholder approval) by selling their operations and assets in several transactions, then returning the proceeds to shareholders along the way.  Disclosed in the announcement, possibly to convince shareholders to vote for the liquidation, management announced an estimated distribution amount:
While no assurances can be given, the Company currently estimates, assuming the sale of its assets pursuant to its monetization strategy, that it could make aggregate liquidating distributions to stockholders of between approximately $92 million and $123 million (approximately $3.00 and $4.00 per share of common stock, respectively, based on 30,752,470 shares of common stock outstanding as of September 2, 2020)
The stock trades for $2.35 today.

Luby's is a throwback to the old world, they own much of the real estate for their restaurant locations versus leasing them, that's where most of the value is in the liquidation.  They've even previously considered selling the restaurant operations and converting to a REIT at one point.  In the proxy statement they've disclosed the current post-covid value of the real estate (they've hired two separate real estate appraisers):
As of August 26, 2020, we owned 69 properties, consisting of the underlying land and buildings thereon, most of which operate, or have operated in the past, Luby’s Cafeterias and/or Fuddruckers operations. The estimated value of those properties as of August 26, 2020, was $191.5 million.
Hidden Value Blog did a nice write-up on the situation a few months ago and did more diligence than me on the underlying real estate portfolio in order to validate the company's appraisal, worth a read.  Most of the real estate is in Texas, which should hold up fairly well, major cities like Houston, San Antonio and Dallas all annually rank near the top of job growth and new home construction.

The company has ~$63.7MM of gross debt, $10MM of which is a PPP loan that will likely be forgiven by the government.  Without giving value to the restaurant operating entities or on the downside expenses regarding the liquidation, the value of the real estate is potentially worth just over the top end range of $4/share.  There's reason to believe that management might be understating the distribution range, in the background section of the proxy statement, Luby's financial advisor presented the following range on 7/20:
Duff & Phelps noted a reference range of aggregate potential liquidation proceeds available to holders of Luby’s common stock from $127.0 million to $172.1 million or $4.15 to $5.62 per share of Luby’s common stock, based on an estimated 30,625,470 shares of common stock outstanding and the Company’s estimates of value for its owned real estate.
Later in the proxy, its mentioned that the Duff & Phelps estimate didn't reflect the current real estate portfolio, but that seems odd since any real estate sales in the interim would be netted off against net debt.  Or it could just be a financial advisor telling a management team what it wants to hear.

Timing and the duration of a liquidation are always a big risk, these take twice as long to wrap up as you'd think, especially the last puff which can be frustrating if you're late to the situation.  However in this instance, much of the distributions will likely take place in the next 6-12 months as the company has been in active discussions on each of the assets for months.  It is mentioned a few times in the proxy that the distribution estimation is based on actual indications of interest for each asset, reading the tea leaves, it seems likely we'll see significant asset sales in the near term.  I wouldn't be surprised to wake up and see news that Franchise Group (FRG, still long) was buying Fuddruckers after their failed attempt to buy another struggling chain in Red Robin (RRGB) last year.

I've participated in a few liquidations over the years, the only time it worked out poorly for me is NYRT, in that instance an activist came in with overly lofty projections in order to win over shareholders so they could earn management and incentive fees.  Here the liquidation is more of a white flag, management has been in place for two decades and should have a sense of the value of their assets, they also own 30% of the shares and thus aligned to get maximum value within a reasonable time frame.

Disclosure: I own shares of LUB

Monday, August 31, 2020

NexPoint Strategic Opportunities: CEF to REIT conversion, Possible NXRT Replay

Back in 2015, closed end fund NexPoint Strategic Opportunities (NHF) (then known as NexPoint Credit Strategies) spun out NexPoint Residential Trust (NXRT), a value-add class B multi-family REIT it had incubated inside the CEF, NXRT went on to 4-5x over the next several years (unfortunately I only caught about 2x of that).  Last week, news came out that NHF shareholders voted to convert the fund to a REIT, possibly setting up another similar opportunity for a multi-bagger as the valuation metric evolves from a discount to NAV story to a multiple on FFO story.

The thesis here is a bit incomplete at this stage but promising if you followed NXRT, NHF trades at $9.45 or 55% of net asset value (pre-covid that discount was more in the 15% range), as part of the conversion to a REIT they'll be selling non-REIT related assets presumably near NAV of $17.19 per share, capturing that discount by then buying distressed real estate in the post-covid fallout.  By applying a similar NXRT value-add strategy, NHF will look to sell newly stabilized assets and then recycling that capital back into opportunistic real estate, rinse and repeat, creating sort of a multiplier effect.  The new-REIT will have a pretty wide investment mandate, essentially any asset class is fair game according to the proxy although I assume they'll stay away from multi-family and hospitality/lodging as NexPoint already has publicly traded REITs that focus on those sectors.  The public REIT market likes simple stories, this doesn't appear like it will be one, at least not initially, but NHF does intend to maintain a monthly dividend, so it could entice retail investors interested in yield.

NHF's current portfolio is sort of grab bag of assets, looking at it and its seems a bit incoherent, many readers will recognize some of the individual equity names, several bankruptcy reorgs and other special situations, NHF even has 8 shares of NOL shell Pendrell for those looking to pick some up in the coming months.  They also own CLO debt and equity, which has generally held up well through the crisis and are probably worth more than where they're marked.  But 25% of the portfolio is in a wholly owned REIT they've once again incubated, NexPoint Real Estate Opportunities, which owns self-storage facilities, a Dallas office building (City Place Office Tower), a new construction Marriott hotel in Dallas and a single family rental operator.  Again, not a real coherent strategy, this idea is a bit of a leap of faith based on their past track record and we'll likely know more in the next 6-9 months through this conversion.  I picked up a smallish position with the intention to add more as the story unfolds.

Other quick thoughts:
  • NHF post REIT conversion will be externally managed, the fee agreement has an expense cap at 1.5% of assets for the first year and there are no incentive fees.  This is a similar setup to NXRT, I believe some of the "investor friendly" aspects of the fee agreement are related to being a historical 40 act mutual fund and not just out of the kindness of management's heart.
  • Speaking of management, James Dondero will be the CEO, he has a litigious reputation (feel free to Google), but again, hard to argue with what the team did with NXRT and he owns 11.5% of the fund/stock.
  • They have a repurchase plan in place that allows them to repurchase 10% of the stock over a one year period (plan was put into place on 4/24/20), unclear if they've acted on it at all or if they would with the new change in plans.
  • One big benefit of being a REIT over a CEF will be index inclusion, joining the REIT indices should improve the valuation and analyst coverage.
Disclosure: I own shares of NHF

Front Yard Residential: Internalizing Management, Covid Tailwinds

I'm slow and full warning this is a completely unoriginal idea, feel free to read better write-ups here and here, but I took a position and as part of my process I wanted to write it up.  Front Yard Residential (RESI) is a REIT that owns approximately 14,500 single family home rentals ("SFRs") primarily across the south and southeast.  Front Yard has a mixed history, it was created and externally managed by Altisource Asset Management (AAMC) to house a non-performing loan portfolio that has since morphed into an SFR REIT.  Prior to the covid-shutdown, Front Yard agreed to be bought by Amherst (PE firm that has a SFR strategy) for $12.50 per share, that deal was terminated quickly once the severity of covid came to light in what looks to be in hindsight an overreaction.  Several months later, the stock has partially recovered, Front Yard trades at ~$9.60 and seems to be in a better position than it was pre-Amherst deal, the elevator pitch:
  • Front Yard's liquidity and leverage improved as a result of the termination, Amherst paid a termination fee of $20MM in cash, plus bought $55MM of newly issued stock from Front Yard at the deal price, $12.50/share, making Amherst one of the largest investors in Front Yard with a 7.5% stake.  Lastly, Amherst also agreed to be the lender on a $20MM loan that is currently unfunded.
  • There has been a quick and dramatic reversal of the popularity of cities, now they're seen as problematic both for pandemic/distancing reasons and recent social unrest, pushing people out to the suburbs in search of affordable space and relative perceived safety.  Single family homes have been one of the largest beneficiaries of this crisis, home prices are up, mortgage rates are way down.  But for many, home ownership is not an attractive option due to a lack of savings/credit or the desire to be mobile, thus a SFR could be a reasonable option.
  • Front Yard has long been sub-scale, only recently in the last year or so did they internalize the property management function and then this month they announced the internalization of their corporate management.  The incentives are finally aligned, but it doesn't fix the sub-scale part as it is only a fraction of the size of larger publicly traded SFR peers in INVH and AMH.  The board sold it once and there's been continual consolidation in this decade long SFR theme following the housing fallout from the last recession, it seems likely that Front Yard would once again be a consolidation target when things settle down further.
Invitation Homes (INVH), which is the legacy Blackstone and Colony portfolios, and American Homes 4 Rent (AHM) are the two scaled SFR REITs, both have good investor presentations that lay out the investment thesis for SFRs:
The addressable market is large, fragment and growing which should be a tailwind for institutional platforms, part of the argument for large platforms like the SFR REITs is the professional property management, which could equal more peace of mind to the customer.
The big non-covid related tailwind is the aging of the millennial generation, the largest cohort was born in 1990 and thus are turning 30 this year, entering a time when they'll likely want more space and start families.  The downside of the model is well known, its hard to gain scale and positive operating leverage unless you have a high concentration of homes in a locality.  INVH talks about 5000 being the scaled up number in a city, back to Front Yard, they only have one market even approaching that number with 4200 homes in Atlanta, the next largest market is Memphis at 1275 homes, again highlighting Front Yard's lack of scale, it's not just about total units but the number of units in a market.  Front Yard's properties are also generally older and cheaper than their two larger peers making their problems even more challenging (higher maintenance capex as a percentage of rent, oh and of course, actually collecting rent as covid related aide starts to slow down).

Not to pile on, but the other problem with Front Yard is leverage, they're highly levered which will make it difficult for the company to reach scale given where the stock trades.  High leverage and a low stock valuation should essentially handcuff the newly internalized management from pursuing a go-it-alone strategy as additional capital raises will be difficult to justify as it no longer just raises fees for the external manager.  The only reasonable option seems like another sale.

Given Front Yard's recent troubles and warts, its hard to value it just based on a cash flow metric, single family homes are gaining in value, especially recently with record low interest rates and limited home building since the last recession crimping supply.  Front Yard puts out an adjusted investment in real estate number that lines up when they've purchased homes or made capital investments and the appreciation in the time since those investments were made.
Obviously there should be a lot of caveats when using that number, a true one-by-one liquidation of Front Yard would take a substantial amount of time and expense to complete, and some depreciation is certainly real in these rentals, but I think it provides some additional context to the valuation.  After giving effect to the Altisource termination payments of $54MM (part of that is RESI acquiring some assets from AAMC), the enterprise value of Front Yard is ~$2.1B or about an 80% of unlevered asset value, given the high leverage of $1.5B of net debt, Front Yard is trading close to 55% of levered net asset value of ~$17.50 a share.  Again, I don't anticipate an acquirer paying a full price, but given recent trends in home prices and a migration to the suburbs, I could see Front Yard being acquired for more than the $12.50 Amherst agreed to in February.

Disclosure: I own shares of RESI

Sunday, August 16, 2020

Colony Capital: SOTP to Earnings, Digital Infrastructure Pivot

Back in April, I wrote up Colony Capital (CLNY) from the perspective of buying the preferred stock (read it for some background), today I'm going to take a shot at making the bull case for the common stock.  Colony has burned many real estate and value investors by going almost straight down since it merged with NorthStar Asset Management (NSAM) and NorthStar Realty Finance (NRF) in 2016. Back then it was going to be the next Brookfield Asset Management (BAM) by managing and co-investing in publicly traded REITs and private equity style real estate funds.  Last year, Colony announced a plan to focus on digital infrastructure, here's the quick new elevator pitch for Colony today:
  • Marc Ganzi took over as CEO (from Tom Barrack who is now Executive Chairman) of the company to effectuate the company's pivot from owning/managing traditional real estate to digital real estate (think towers, data centers, fiber, etc).  Ganzi has been a deal maker in the digital infrastructure space for a couple decades, in 2002 he co-founded Global Tower Partners, a private tower REIT, and ended up selling it in 2013 to industry leader American Tower (AMT) for $4.8B including debt.  Subsequently, Ganzi founded Digital Bridge Holdings ("DBH"), a PE fund with 6 digital real estate portfolio companies, which Colony invested/acquired DBH to bring him into the fold and lead the transition.  He has a good reputation as a deal maker with a legitimate track record, pair him with the tailwind of consumer demand for data being accelerated by work-from-home and other corona trends, the new strategy seems potentially promising.
  • Colony fits the "buy on the balance sheet, sell on the income statement" thesis that many investors (including me) look for, the value of the legacy assets today cover the market cap, as the company shifts to a manager/owner of more attractive digital infrastructure properties, the stock should earn a multiple on earnings versus languishing as a discounted sum of the parts story.
  • Colony doesn't have a natural investor base, many investors have been burned by the continual strategy shifts over the years. It is a REIT that doesn't pay a dividend, is overly complex and it is in the early days of their strategy shift -- so they're still a year or two away from being picked up by tower and data center investors.  The digital REITs dominate the top holdings of REIT index funds and trade at very lofty valuations.
On 8/7, Colony reported second quarter earnings and it was the first real chance for Ganzi to articulate his vision for the go-forward version of the company, and with it, released an investor day style presentation.  It's always a bit scary (be skeptical!) when you feel like a presentation was targeted directly at you, but Colony laid out the following few slides on why to invest in Colony:

During the quarter, the company took $2+B impairments to their legacy real estate holdings ("legacy" in this context means anything not digital, which is almost all of the balance sheet assets), basically kitchen sinked to reset the table for Ganzi, Colony spun it as covid accelerated the need for them to move quickly into their digital strategy given the demand on data/technology, but it also means potentially selling legacy assets in hard hit sectors to fund that pivot at an inopportune time.

At the top of slide is the digital pieces of the business, they primarily have two balance sheet investments in two separate data center business, the first is DataBank which they purchased for $186MM from Ganzi's DBH, possibly a less than arms length transaction but its also possible that they got a reasonable deal, who knows the business better than Ganzi?  The other thing to note is they've revalued their digital investment management company, Digital Colony, in this SOTP slide for the recent capital raise they did with institutional investor, Wafra, that bought 31.5% of Digital Colony for $250MM.  After that sale and a convertible bond offering which is now above the strike price, outside of the preferred stock, Colony has a net cash position at the corporate level.

The debt at the legacy assets is all non-recourse and generally asset specific, each asset/portfolio can almost be thought of as a call option in these times, the value of hotels or senior living facilities are clearly down, but depending on the pace of the economic recovery, these values post write-down might prove to be too low on certain assets.  In my preferred stock post, I wrote off the hotel assets completely and just assumed they'd hand back the keys, and that still might be the case as some industry rags have reported.  But Colony's hospitality portfolio is really divided into 7 separate entities (6 of which are reported under hospitality, 1 of which is under "Other Equity & Debt" as it was acquired through foreclosure), some of these are very likely going back to the lender, especially the 4 that have CMBS financing where their is little negotiating that can happen with the lender as the special servicer is generally bound contractually to foreclose.  The other 3 it's a bit murkier, but there's potential value there if things recover and Colony is able to hold on for another year or two before selling.  The healthcare facilities while down, seems salvageable to me, most of the properties in here are triple net lease and while covid has destroyed the senior housing sector (who in the right mind would place a love one in a senior housing facility right now unless that was the only option?), CLNY's rent collections have recently come in at 96%.

Another chunk of the legacy book is Colony Credit Real Estate (CLNC), a publicly traded credit REIT, they both manage the company and own 36% of it.  CLNC recently brought on former Ladder Capital (LADR, disclosure, still long) executive Michael Mazzei to take over the management of the company, I have a lot of respect for the Ladder Capital management team and see this hire as an important step in the turnaround of CLNC.  Historically, CLNC was originally thrown together from a pile of CLNY assets and a few NRF sponsored non-traded REITs, non-traded REITs are generally indiscriminate in what they buy in order to fund growth and increase the management fee to the external manager.  CLNC plans to eventually internalize although that plan is on ice for now as the stock trades for roughly half of book value (book value is a decent proxy for net asset value here).  CLNC has a large CRE CLO that they manage and use as balance sheet financing, to-date all the assets in that vehicle are current, its hard to tell if servicers are advancing funds or borrowers are using interest reserves to make payments, but given all the other assets and liquidity sources in CLNC, if a loan did go into default, they'd be able to buy the problem loan out of the CLO and maintain the coverage tests and all valuable cash flow to the junior tranches which CLNC owns.  Unlike other mortgage REITs, CLNC didn't have any securities portfolios liquidated due to margin calls, and given the current support credit markets are receiving, including possibly new supportive legislation, I can see a world where CLNC trades back up closer to current book value in the next 12 months.

Elephant in the room, most of the value in the legacy portfolio is in their "Other Equity & Debt" sleeve, they've slightly improved their disclosures here but its hard to know what's what and the overall value here:
Some of this portfolio seems like nonsense in a REIT, like the partnerships with Sam Zell in oil & gas, and the rest of it sounds risky and heavily levered to commercial real estate quickly recovering from the covid-crisis.  I'm taking a bit of a leap of faith here that management has indeed brought the carrying values down to market.

Moving to the future, Colony explicitly calls out the opportunity to eventually be valued off of an earnings multiple, again, be skeptical!:

*If* Colony can meet these management projections, the stock is a multi-bagger from the mid-$2s.  I don't know the digital infrastructure space well (possibly at all), but obviously part of the trick here is buying assets in the private space below what public market investors are paying for the same assets.  The math works better at lower valuations, but it still could possibly be attractive here as the Colony gets a little added leverage by the management fees.  For example, if they only invest in 20% of the company via their balance sheet (as with DataBank) they get the benefit of their management fees across 100% of the asset, thus bringing down the proforma multiple paid.  It's not clean and what public market investors will pay up for immediately, but makes some logical sense.

Another interesting, potentially irrelevant data point, the stock was around $5 when Ganzi came on, but you can get a sense of what the business plan looked like at the time when looking at his incentive package:
In addition, in connection with entering into the employment agreement, the Company granted Mr. Ganzi a sign-on performance-based equity grant (the “Sign-On Award”) in the amount of 10,000,000 long-term incentive units in CCOC (“LTIP Units”). The LTIP Units will vest if the closing price of shares of the Company’s Class A common stock, par value $0.01 (the “Class A common stock”) is at or above $10.00 during regular trading on the New York Stock Exchange over any 90 consecutive trading days during the five-year period beginning on the Effective Date. The Sign-On Award is generally conditioned on Mr. Ganzi’s continued employment until the performance-based condition is satisfied.
A cool $100MM (not Elon Musk incentives, but still a nice chunk of change!) if he can reach the projections outlined in the investor presentation at current market multiples, which initially seem pretty out there, speculative sure, but the transformation seems possible to me.  That upside is mostly a jockey play, Ganzi isn't super well known outside of the digital infrastructure space, but he can now sort of be viewed as the new founder of "Digital Colony" (likely only a matter of time before the company adopts that name), spent the last 7 years building out DBH/Digital Colony, sure he did cash out partially when Colony bought his firm but part of the consideration was OP units at $5+ share price equivalent, plus you'd assume he's got some reputational capital behind the proforma company.  At the end of the latest quarterly call (transcript from, in a bit of salesmanship and possibly a bit (or a lot) of hubris, Ganzi compared Colony's stock price today with industry leaders like American Tower and how it once traded at $2 as well, AMT now trades at $250+.  A bit crazy, but maybe not?
Well, listen, thank you. It's been an incredible first half of the year. Once again, I want to thank our Board. I want to thank our Chairman, Tom Barrack. I want to thank our team. This is an incredible team we have here at Colony Capital. I think we unveiled some of that to you today. But this doesn't happen without a great team focused on continuing to find the right home for our legacy assets and continuing to grow our business going forward. I think we've made the case today why this is a great moment in time to buy Colony. And I'd ask all of you who've been investing in the sector for 2 decades, who've watched my career, to remember those sort of seminal moments when American Tower and Crown and SBA were all trading sort of sub-$2. Those were really interesting points in time to buy digital infrastructure. Colony today trades slightly under $2. I'd encourage you guys to look at your history books, think about this management team, think about our business model and think about where we're going.
A good question to ask is how else does Marc Ganzi get paid? He gets a few different pieces of revenue like the 10% of the incentive fee allocation, are his equity grants too far out of the money to be meaningful? He's clearly a rich guy with a big monthly budget (big polo player, owns/founded a polo club); lives in Boca Raton and is managing the business from there, town has a bad reputation among investors for businesses headquartered there.  Colony's common stock is a bit speculative from here, but I flipped my preferred stock for the common after the earnings call.  It rhymes with a few other investments over the years that have worked out well, basically a complex grab bag of assets that's moving into an easy understand company in a sector public market investors adore.

Disclosure: I own shares of CLNY

Tuesday, July 7, 2020

GCI Liberty: Stock-for-Stock Deal with Liberty Broadband

How can you be an event-driven investor and not own a couple positions in the Malone universe?  There are people with smarter takes than me on the Liberty complex and cable (Andrew Walker for one), but with the news coming out last week that GCI Liberty (GLIBA) and Liberty Broadband (LBRDA/K) are in talks to merge, it seems timely to take a look at the transaction and what Liberty Broadband might look like after the deal closes.  The talks are only preliminary and not final, but it's safe to say that a transaction is a near certainty to take place as it's long been thought a GLIBA/LBRDA combination which pools together Liberty's investment in Charter Communications (CHTR) would make an eventual consolidation with CHTR simpler.

Quick and incomplete origin stories:
  • GCI Liberty is the result of a 2018 deal between Liberty Interactive's Liberty Ventures (old LVNTA) tracking stock merging with General Communications ("GCI", old GNCMA), the largest provider of cable/telecom to Alaska, eliminating the tracking stock structure and creating an asset backed stock with GCI as an operating subsidiary.  As a result, GCI Liberty holds about 70% of its assets in LVNTA's historical investments in CHTR, one as the result of TimeWarner Cable's (TWC) merger with CHTR and then through an investment in Liberty Broadband which in turn funded the cash portion of the acquisition of TWC by CHTR.  GCI Liberty also contains a legacy home-run investment in Lending Tree (TREE), the financial services online marketplace.
  • Liberty Broadband also traces its roots similarly, it was a 2014 spinoff of Liberty Media (old LMCA) which held LMCA's stakes in CHTR and TWC, the TWC stake was then folded into CHTR as a result of the above mentioned CHTR/TWC deal, leaving Liberty Broadband as substantially just a pass-thru to CHTR (they have a tiny active trade business to keep the spin tax free).
Creating an NAV for both companies is a fairly straight-forward exercise (saying that, I probably made some mistakes - feel free to point them out - so do your own home work).
The main variable input for GLIBA is how you want to value GCI, the operating subsidiary, I've chosen to use a 9x multiple (essentially the multiple LVNTA paid for it) on TTM EBITDA.  It traded well below that prior to the acquisition, but with the eventual path being a CHTR acquisition, there's some synergies that could be added and thus it seems as fair of a multiple as any to me.  Then there's the exchangeable debt, much of GLIBA's direct Charter investment is pledged to exchangeable bonds that either directly reside on GLIBA's balance sheet or some legacy exchangeables that are at GLIBA's former sister tracker, Qurate Retail Group (QTREA), and GLIBA is responsible for the in-the-money exposure since all the CHTR shares moved over to GLIBA in the hard split.  An exchangeable bond is sort of like a convertible bond, but instead of having the option to convert into the issuers stock (would be GLIBA here as an example), the bondholder has the option to receive shares in another reference security (CHTR in this case, which is in the money at a $370 strike price, thus the liability increases as CHTR's stock continues to perform).  As a result, almost all of GLIBA's CHTR exposure is in LBRDK and featured a "double discount", as shown below, LBRDK trades at a discount to its investment in CHTR and GLIBA traded at a discount to its primary investment in LBRDK.
Liberty Broadband is simpler, as mentioned, it is essentially a pass-thru for CHTR that trades at a mid-teens discount to CHTR.

What might the proforma company look like?
The proposed exchange ratio is 0.58 shares of LBRDK (the non-voting LBRD shares) for every share of GLIBA (so GLIBA share holders go from Class A to Class C, not that it really matters), by combining the two, Liberty Broadband is effectively able to buyback the LBRDK shares GLIBA owns and share the benefit of closing that second layer of discount between the two shareholder groups in a stock-for-stock merger.  GCI Liberty shareholders naturally receive most of that benefit, GLIBA goes from having a ~$83 NAV per share to a ~$90 NAV per share (on the GLIBA sharecount), Liberty Broadband shareholders get a smaller benefit moving from ~$155 to ~$157.

Other thoughts:
  • Obviously I'm missing any analysis on CHTR, others have covered it in great detail, they're the second largest cable provider in the U.S., financially they utilize Malone's levered equity strategy: levered 4.5x and use FCF to buy back stock in order to maintain that leverage.
  • No thoughts on the ultimate timing of a CHTR takeout, but I sleep pretty well knowing that's the eventual path, Malone has a history of consolidating these investment HoldCo's back into the operating company (Direct TV and Expedia are good examples).  As a result of LBRDK's ~25% ownership stake, Liberty gets 3 seats on the board, appointed the current management team, seems likely that their influence will result in the closing of the discount in a tax efficient manner.
  • GLIBP is a big beneficiary to the combination, the preferred shareholders gain a whole lot more equity cushion below them and keep the elevated 7% dividend rate.
Disclosure: I own shares of GLIBA

Tuesday, June 30, 2020

Mid Year 2020 Portfolio Review

What an all around emotionally exhausting six months.  From an investing perspective, at one point my blog portfolio was down well over 50% for the year, erasing all gains from 2019 before rebounding with the market through most of the second quarter.  I try to be transparent because it's somewhat fun and keeps me accountable, I'm down -24.01% compared to the S&P being down -4.04% for the first half of the year.  My IRR since inception is 18.5%, a bit below my long-term stretch goal of compounding at 20%.  Big dollar value losers have been mostly long held positions in Liberty Latin America (LILA), Par Pacific (PARR), MMA Capital (MMAC), and Howard Hughes (HHC).
I continue to be optimistic about markets and that long term humanity will beat the virus (honestly not sure how you can operate, especially with kids, any other way while remaining sane) and that life will return to a somewhat changed, but recognizable normal. As you get older, time seems to pass quicker, look back on the events that happened only 3 years ago (i.e., for sports fans the Patriots comeback against the Falcons in Super Bowl 51 happened 3.5 years ago) and they feel like they happened recently, coronavirus is here with us now and the world "normalizing" in 2022 seems far away, but it really isn't if you take a step back.

In my day job, I help support a business that is a large service provider to leveraged credit asset managers -- March and April were pretty historic in terms of the quick downfall and then subsequent recovery in anything with significant credit risk. A couple brief observations: 1) during the financial crisis of 2008-2009, the root cause of the problem was in the financial system, in data points I'm seeing, I don't believe that to be the case today and once the medical side of the equation works itself out, we should see a more robust and accelerated recovery.  There are a lot of long form reporting pieces about risks to the banking system, but I just don't see it, could be wrong, but it feels like click bait and creating parallels to the GFC that just aren't there; 2) There's plenty of new activity/fund formation in credit markets, in 2008 (well really in the summer of 2007) all securitization activity ground to a complete halt and was essentially zero until late 2010.  Today, there is less activity but still plenty going on in credit markets.  Capital is available to borrowers in a position to survive, defaults will pick up from here but most of the bankruptcies to date are either in credits that were already in distress or the riskiest of hospitality, like Cirque du Soleil. Same as everyone else I'm fascinated with the speculative trading activity around bankrupt or near-bankrupt equities, but the process still seems to be working to me, although with strange speculative bouts, but companies that generally shouldn't being saved, aren't being saved.  Either way, I get it, it's fun to be snarky.  But if credit is flowing to the high yield and leverage loan markets (yes, I know, Fed intervention), my sense is we make it to the other side of this mess.

  • I blew out of most of my merger arb and other similar ideas early on during the downturn, contributing in my small tiny way to spreads widening across many deals; a particularly painful one was Asta Funding (ASFI), I sold at $9.76 when they had a go-private offer for $10.75, that offer has since been increased twice and now stands at $13.10.
  • Everyone is dealing with disruptions, I'm stuck working from home in my basement on a folding table, my research process is a mess and it's also hard to research stocks with so much volatility, once I feel like I know the basics, the situation might have changed.  I try not to let the blog influence my investment activity (i.e., buy things because they'd make for an interesting post) but its still in the background a bit, so while I want to post more, apologies if I'm a little more sporadic through this crisis.
  • I sold options for the first time in a long time recently, none currently outstanding, but with a few positions in my mind (could be totally wrong) the value of the underlying assets/business is much else volatile than the stock price, good examples would be GLPI which is essentially mezz debt of PENN (PENN can raise capital whenever it wants as long as Dave Portnoy is pumping the stock to his loyal followers) or something with scarce trophy assets like MSGS.
  • Speaking of GLPI, I initially didn't own a position when I wrote it up in April, but it is now one of my higher conviction ideas.  Unlike the other gaming REITs which have a significant portion of their assets in Las Vegas, GLPI is focused on the regional casinos, has adequate diversification among geographies as Covid heats up in less expected locations, PENN has already raised equity on top of transferring ownership of the Tropicana to GLPI.  The NFL seems pretty committed to having a full season one way or another this year and the Barstool sports betting app is still set to launch in August ("DDTG" is likely one giant marketing campaign for their app launch), I have a hard time seeing how PENN doesn't restart making full cash rent payments in September.
  • I get asked about Howard Hughes a lot as I've been a long time bull, I did add considerably after the equity raise -- at first I was a little disappointed, the story has always been that the company is able to self finance itself, all development projects are fully funded with committed financing, etc., Ackman likely took advantage of his hedge windfall and quickly deployed it in HHC the only way he reasonably could, through a secondary.  While the business remains challenged given their markets are particularly hard hit by Covid, I also think they continue to have long term appeal and the crisis might be a catalyst for restarting the home-building sector.  For the next year or two, HHC is likely more of a land play than a commercial real estate developer, but with the Ackman equity raise, the worst case scenarios are likely off the table for now.
  • Most of my other positions are fairly well covered in previous posts, feel free to ask any questions in the comments and I'll try to answer them as best I can.  However, generally in a sit on my hands mode for the moment.
Current Portfolio:

For those doing the math, I did add some cash to the portfolio in March, I'm doing a money-weighted return for my performance metric which should be reasonable as I've never withdrawn from the account, only added, IRR and CAGR should be pretty close.  Another caveat, average cost is today's average cost, I had some losses earlier in the year, typically if you sell a portion of a position you want to sell the higher cost basis shares but thus far I've been selling the lower to soak up taxable losses.

As always, on the lookout for new ideas, feel free to reach out and try to enjoy your holiday weekend as best you can and stay safe.

Disclosure: Table above is my blog/hobby portfolio, I don't management outside money, its a taxable account, and only a portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Wednesday, April 22, 2020

Ladder Capital: Internally Managed mREIT, No CRE CLO Debt

In the previous post I sung the praises of the use of non-recourse secured debt for Colony Capital (CLNY), here I'm going to do the same but for the use of unsecured/non-CLO debt at Ladder Capital (LADR), a commercial credit/mortgage REIT with an $830MM market cap.  Ladder has been punished alongside their commercial mREIT peers and currently trades at approximately 50% of 12/31 book value (which will almost certainly will come down), the recovery won't be overnight, but Ladder is well positioned to survive the corona crisis and provides a safer (not safe) way to play the rebound in the mortgage REITs for the following reasons:
  1. Ladder is an internally managed REIT with significant insider ownership and management seems to run the company as owners versus as a fee revenue stream.
  2. Senior secured portfolio -- in particular their CMBS portfolio is predominantly AAA (which the Fed recently announced is eligible for TALF financing) versus many of their peers who play in the BBB to B space and have had trouble with margin calls.
  3. Unsecured and term repurchase financing gives Ladder the opportunity to work with their borrowers on modifications without getting cash flows shut off like they would in a CRE CLO or face margin calls as they would in short term repo.
Quick overview of Ladder Capital, they were founded shortly following the last market crisis in 2009 (and listed in 2014) by the former UBS real estate team, that team is still largely together today and as a group own 11% of the company.  Ladder primarily plays in four areas of CRE finance: 1) transitional whole loans held for investment; 2) stabilized whole loans to be sold into CMBS (hopefully recognizing a gain on sale); 3) CMBS held for investment; 4) single tenant net lease properties; and then they do have a small sleeve of other operational properties partially the result of any foreclosures on the whole loan portfolio.  They portray themselves as having a strong credit culture and that seems to have played out in the last several years, prior to the coronavirus crisis, they've only had one realized loss on a loan, and unlike other mortgage REITs they don't have any legacy issues or at least don't play the trick of segmenting a core and legacy portfolio when things don't go as planned.

Roughly half of their assets fall into the first and second category, commercial real estate loans that Ladder originates themselves either on transitional properties (meaning a developer is re-positioning the property in some way) for their own balance sheet or on stabilized properties which Ladder will originate to distribute via the CMBS market.  Many if not most of the transitional variety will require some kind of forbearance or modification, construction crews may or might not be working, and certainly any up leasing activity or the time to rent stabilization where the property could be refinanced with longer term financing is pushed out.  The CMBS conduit market is already showing early signs of thawing, and on their Q4 call, Ladder mentioned having a fairly small amount of loans "trapped" in their warehouse awaiting to be sold into the CMBS market.  Here's their slide on their loan portfolio as of January:
As you can see, about 25% of the portfolio is exposed to the highest risk retail and hospitality sectors.  Given their middle market lean, the hospitality portfolio tends to be more weighted towards self service than convention hotels or resort destinations that may take longer to recover.  I tend to think most of these mortgage REITs have similar assets, capital is a bit of a commodity, but possibly Ladder is more conservative than some others.

The right side of the balance sheet is where I think Ladder is more interesting than others -- many commercial mREITs finance their transitional loan portfolios through CRE collateralized loan obligations ("CRE CLOs") where the loans are pledged to an off balance sheet SPV which then issues notes to fund the SPV's purchase of the loans.  The notes will be issued in various tranches depending on investor risk tolerance with the sponsor (the mREIT) of the CLO retaining the junior bonds and equity.  If the underlying collateral doesn't perform, there are asset coverage tests in place to divert cash flows from the junior note holders to pay the senior note holders and protect their position in the transaction.  In the years following the financial crisis, the asset coverage test thresholds are paper thin to the point where one or two modified loans in the portfolio will trip the diversion of cash flows away from the mREIT to pay down the senior note holders.  In practice, what often happens is if one of the underlying loans is in default or requires modification, the mREIT will purchase the loan from the CLO at face value and work it out off to the side as to not jeopardize their cash flow lower down the payment waterfall.  However, in the current environment where there will be many defaulted or modified loans, it might be difficult or just not possible due to margin calls elsewhere in an mREIT's balance sheet to purchase the non-performing loans from the CLO and thus shutting off cash flows.

Ladder had previously issued two CRE CLOs but wound those vehicles up in October and is currently out of that market.  Instead, Ladders funds its loans through a combination of unsecured bonds where they are a BB credit and through term repurchase facilities.  In their term repurchase facilities, they've always stressed in their filings that they've always kept a cushion available to allow them to meet margin calls in a cashless manner.  Neither have the feature of a CLO where cash flow of the underlying assets is completely shut off and may allow Ladder some breathing room in working through modifications with borrowers.  Here's from p74 of the 10-K, they've received margin calls and met them thus far (at least what's been disclosed), many mREITs tout their total available credit capacity but I think that's less meaningful than the borrowing capacity on their currently pledged assets.
Committed Loan Facilities
We are parties to multiple committed loan repurchase agreement facilities, totaling $1.8 billion of credit capacity. As of December 31, 2019, the Company had $702.3 million of borrowings outstanding, with an additional $1.0 billion of committed financing available. Assets pledged as collateral under these facilities are generally limited to first mortgage whole mortgage loans, mezzanine loans and certain interests in such first mortgage and mezzanine loans. Our repurchase facilities include covenants covering net worth requirements, minimum liquidity levels, and maximum debt/equity ratios.
We have the option to extend some of our existing facilities subject to a number of customary conditions. The lenders have sole discretion with respect to the inclusion of collateral in these facilities, to determine the market value of the collateral on a daily basis, and, if the estimated market value of the included collateral declines, the lenders have the right to require additional collateral or a full and/or partial repayment of the facilities (margin call), sufficient to rebalance the facilities. Typically, the lender establishes a maximum percentage of the collateral asset’s market value that can be borrowed. We often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon at a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
Committed Securities Repurchase Facility
We are a party to a term master repurchase agreement with a major U.S. banking institution for CMBS, totaling $400.0 million of credit capacity. As we do in the case of borrowings under committed loan facilities, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis. As of December 31, 2019, the Company had $42.8 million borrowings outstanding, with an additional $357.2 million of committed financing available.
Uncommitted Securities Repurchase Facilities
We are party to multiple master repurchase agreements with several counterparties to finance our investments in CMBS and U.S. Agency Securities. The securities that served as collateral for these borrowings are highly liquid and marketable assets that are typically of relatively short duration. As we do in the case of other secured borrowings, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
The other issue many mREITs are having is with their CMBS portfolios, mREITs like XAN or CLNC tend to buy CMBS in the BBB-B rating range or simply unrated, Ladder is predominately in the AAA and AA rated tranches of CMBS and as a result have significant credit enhancement via subordination.  While the pricing of AAA CMBS did drop, the Fed recently announced an expansion of the TALF program in which they'll provide financing on AAA CMBS issued prior to 3/23/2020.  In a bit of a departure from the other assets classes they're willing to finance, CMBS will only be legacy versus only new issuance.  I take this two different ways, 1) the Fed wants to stabilize CMBS prices today; 2) they're not concerned with needing to provide support for new issuance to resume like they are in other ABS markets.  Both are good for Ladder as a CMBS investor and as a loan originator to the CMBS market and it seems to be having its intended result, take the iShares CMBS ETF for example (tracks investment grade CMBS), it has recovered its losses and is up on the year.

Since I started drafting this post, Ladder put out an additional "business update" press release that is becoming all to regular for public companies these days.  In it they outline how they have $600MM of cash after some maturities on their loan portfolio plus they sold assets at 96 cents on the dollar and they have $2.3B of unencumbered assets.  Should be sufficient to get them through the crisis?  The dividend is roughly 20% at $1.34/year, that'll almost certainly get cut/suspended and could provide an attractive opportunity if any remaining yield pigs remain holders.  I like the management here and think we will see most if not all CRE CLOs fail their coverage tests (might be more opportunities once that happens), my sense is Ladder should trade for somewhere in the 75-80% of 12/31 book value range, no science behind it, but I see little risk that they'll be forced to liquidate at fire sale prices or have their cash flows shut off due to asset coverage test failures.

Disclosure: I own shares of LADR

Friday, April 10, 2020

Colony Capital: Preferred Stock, Non-Recourse Debt, Complex Mix of Assets

Colony Capital (CLNY) is a real estate private equity manager and real estate investment company that today fashions itself as a leader in the digital infrastructure sector.  However, it's mostly a complex mess of assets that have been left behind as the company has pivoted strategic directions several times, only to reclassify the old businesses as "legacy" hoping investors forget about them.  But the complexity and random assortment of assets might be beneficial to company today as its not reliant on one asset type (i.e., agency mortgages) or one funding source (i.e., repo agreements) that could subject the company to repeated margin calls and put them out of business completely.  The common stock might be worthwhile as a call option, but due to that complexity, I have a hard time valuing it in any credible way I'm willing to share, instead, the preferred stock seems cheap based on the unencumbered assets and is unlikely to be impaired through this crisis.

CLNY is the creation of Tom Barrack, he's a long time real estate investor and close friend of Donald Trump who is known for speaking at the 2016 Republican National Convention and more recently writing a blog post asking for a bailout of the commercial mortgage market.  Commercial mortgage REITs have recovered quite a bit in the last week or so, but prior to that they were hit with margin calls as the value of their CMBS assets fell and started a chain reaction of forced selling creating more forced selling as prices dropped.  CLNY is not a mortgage REIT, but is the external manager for one in Colony Credit Real Estate (CLNC) and CLNY owns 36% of CLNC's equity, but CLNY and its preferred stock declined alongside the commercial mREITs anyway.

CLNY's current strategy is to "focus on building the leading digital real estate provider and funding source for the occupancy, infrastructure, equity and credit needs of the world's mobile communications and data-driven companies."  They started down this path last July by purchasing Digital Bridge Holdings, a private equity firm that managed six separately capitalized digit real estate companies and a $4B fund it co-raised with CLNY, Digital Colony Partners Fund (which recently acquired ZAYO).  Along with Digital Bridge came a new management team that is slated to take over CLNY on 7/1 and move Tom Barrack to Executive Chairman.  This might be the right strategy, the tower and data storage REITs all trade at rich valuations, if CLNY can fully pivot maybe they'll get some of the benefit of that premium, but most of the value here is in the legacy assets.

Let's start with CLNY's capital structure as of 12/31/19:
CLNY's Q4 Supplemental
CLNY has a fair amount of liquidity following the sale of their light industrial warehouse assets to Blackstone in December and the sale of their equity interest in RXR Realty in February, leaving them with $520MM in cash as of the end of February, plus their undrawn credit facility.  All but $931MM of debt is non-recourse, and then a portion of the non-recourse debt is third party that CLNY consolidates on their balance sheet.

Their main assets are majority interests in two large portfolios (essentially REITs in their own right), one in an assortment of healthcare assets (but mostly senior housing and skilled nursing) and the other in select-service and extended stay hotels with brands associated with either Hilton or Marriott.  Both asset sleeves refinanced their debt in 2019 and pushed out maturities to 2024 and 2026, I haven't spent much time on the covenants, but the debt is non-recourse and under a worst case scenario, CLNY could mail back the keys to the lenders.  In hospitality, I do tend to think extended stay is performing better than other segments (still long some STAY) as its more of a residential replacement than true travel and then select service might recover sooner than destination resorts or convention heavy locations.  But again, non-recourse, a blow up in either or both would be a scary headline but wouldn't take down the entire enterprise, for the below, just going to assume both portfolios are zeroes.

The remaining assets are an interesting grab bag, cynically, it seems like CLNY was used as a way for Tom Barrack to invest with friends or in vanity projects whether it made sense for a public REIT or not:

1) Investment Management Business
When CLNY (originally CLNS) was formed in the three way merger with NSAM and NRF, I figured CLNY wanted to be the next Brookfield Asset Management (BAM), they would mostly be an asset management company and then would have "YieldCos" they would manage and partially own.  They've sort of done that, just not executed as well.  But with the acquisition of the digital business, they have a considerable management company arm that is essentially unencumbered and generates approximately $160MM a year in base fee revenue.
They have started down the path of internalizing the management at CLNC which they'll likely receive additional shares as consideration once the commercial mortgage market settles down a bit.  If you put a 35% margin on $160MM and give it a 10x multiple (just a swag), that's a $560MM business plus the non-wholly owned management companies listed above.  One of which is an interesting venture with Sam Zell (partnering with friends, not sure it fits in a public REIT vehicle), Alpine Energy, that is investing in distressed oil and gas like California Resources (CRC).  As mentioned earlier, they also monetized their investment in RXR Realty for $179MM, which implies a similar valuation I'm placing on the four wholly owned segments.

2) Colony Credit Real Estate (CLNC)
CLNC is mostly a commercial mortgage REIT but does own some net lease properties and other assets, it's suffered like the rest of the sector, but has generally limited CMBS exposure at under 7% of assets, recently closed a CRE CLO which termed out much of its debt, and has been current thus far on any margin calls.  Interestingly, I've only seen margin calls on RMBS or CMBS and not whole loans, whole loans are likely harder to price or more negotiable, might be worth focusing on mREITs with more whole loan exposure than to securitized products.
At Thursday's ~$5 close, CLNC has a market cap of approximately $665MM, trading at about 30% of the last reported book value (likely coming down).  But a 36% ownership at today's depressed prices is still worth $240MM to CLNY, plus the management fee contract but we're including that in the investment management business above.  They do account for their stake in CLNC via the equity method, so its grossly overstated at the moment compared to CLNC's market value, meaning an accounting impairment is likely on the way.  CLNY's long term plan with CLNC is to sell their position down over time once it is trading more inline with book value.  CLNC is interesting in its own right and might deserve a separate post, but for the purposes of CLNY let's say it survives and leave it here.

2) Other equity and debt portfolio
Here's the grab bag of other assets that includes some directly held real estate (sometimes the result of a foreclosure), their $186MM investment in DataBank which is one of the six companies that Digital Bridge manages, a stake in Albertson's which might be one of the few large companies to conduct an IPO this year (can't think of a better year for a grocery store to come public again), and all their co-investments in institutional funds they manage.

This sleeve is valued at $1.8B on the balance sheet and CLNY pre-corona intended to monetize $300-$500MM of assets this year.  That'll likely change, but even putting a significant haircut on the assets, let's say they're worth 30% less in this environment, making the net equity worth ~$900MM, that's probably overly punitive as a lot of this is at cost in their financials, but the exercise is to see how much value is left for the preferred assuming an extended crisis.

This modified SOTP is too severe, but just illustrating that I think the preferred stock is still money-good versus a trading price in the $16-17 range.
At Thursday's close, you also have about $1.2B in CLNY market cap beneath the preferred shares.  There are plenty of investment opportunities with more juice but here you don't have to worry about how much of the portfolio has been liquidated due to repo margin calls.  The preferred stock (there are 4 series, generally the same, some more liquid than others) has about 50% upside to $25 plus any dividends collected along the way as we wait for things to normalize.

Disclosure: I own shares of CLNY Preferred Series G

Wednesday, April 1, 2020

Watchlist: GLPI and Penn National Gaming

There are a number of interesting situations and potential bargains out in the markets today, I typically don't write on companies where I don't own the shares, but for the next few months (however long we're all stuck at home) I might try to push out a few more posts on ideas where I've done some work on but don't own for one reason or another (limited cash), but want to be ready to take advantage of further declines.

One such situation is Gaming and Leisure Properties Inc (GLPI) which is the 2013 REIT spin of Penn National Gaming (PENN), PENN is now the largest operator of regional casinos in the United States and rents most of their properties from GLPI, they're still attached at the hip 7 years later.  GLPI was the first of the triple-net lease gaming REITs that now also includes VICI Properties (VICI) and MGM Growth Properties (MGP); GLPI owns the real estate of 40+ casinos and leases them back to casino operators who pay all the maintenance, taxes, insurance and other property level costs of the property.  The leases are typically structured as master leases and are functionally senior to the traditional debt as their physical casinos are critical to the operation of the business (although mobile will increase in share going forward).  In addition to the triple-net lease business, GLPI owns and operates two casinos due to tax rules at the time of the spin requiring an active business, one in Louisiana and the other in Maryland, both under PENN's Hollywood brand.  Their leases are primarily with PENN, around 80%, they did previously diversify by doing a PropCo/OpCo transaction with Pinnacle Entertainment (PNK) in 2016, but PENN ended up buying PNK in 2018 causing GLPI's tenant concentration to revert back.  GLPI also has Elderado (ERI) as a tenant from when GLPI paired with ERI in the acquisition of Tropicana Entertainment (TPCA), Boyd Gaming (BYD) due to forced divestitures from the PNK tie-up, and Casino Queen (smaller distressed player) on the rent roll.

Obviously, Penn National is in a considerable amount of distress with coronavirus and social distancing, they have closed all of their casinos and furloughed much of their employee base for an indefinite amount of time.  PENN is highly levered, their annual rent is significant at ~$900MM/ year (plus another $105MM in interest on regular debt), with $820MM of that going to GLPI, PENN is current on rent through the April payment, but would be unable to manage through this crisis without some forbearance or risk being restructured which would be disastrous for both GLPI and PENN.  This past Friday, GLPI and PENN entered into a unique transaction:
  • PENN will be free delivering the Tropicana Las Vegas property and operations to GLPI, plus the land under their Hollywood Morgantown development that is scheduled to open around year end for $337MM in credits to be applied to the May, June, July, August, October, and a partial payment towards their November rent.
  • PENN will then lease back the Tropicana Las Vegas from GLPI for $1/year and continue to run the operations and maintain the property.
  • GLPI will engage in a sale process over the next 2 years to sell both the real estate and operations of the Tropicana Las Vegas in order to recoup the rent credits.  $307MM of the $337MM in rent credit is to be assigned to the Tropicana. If the property sells for more than $307MM then the excess would be split with PENN, 25% of the excess would go to GLPI if it sold in the first 12 months, and there would be a 50/50 split in year two, beyond year 2 GLPI would get 100%.  PENN had been rumored to have gotten inbound bids in the $700MM range as recently as this past January for the property, but those buyers are likely long gone.  PENN did purchase the Tropicana for $360MM in 2015 providing some assurance that the property is worth more than the rent credit GLPI is receiving (assuming Vegas isn't permanently impaired by the coronavirus).
  • PENN additionally agreed to exercise their 5 year extensions on their master leases and entered into an option to purchase the operations in 2021 of one of GLPI's owned and operated casino, Hollywood Perryville (MD), for $31MM and enter into a $7.8MM annual lease for the property.
No one will confuse the Tropicana with a high end casino like the Wynn or Bellagio, but it is 35 acres and over 1400 rooms on one of the busiest corners on the strip.  Another tired casino in much worse location, Circus Circus, was just purchased for $825MM by Phil Ruffin in January.  Again, the world has changed, but if things return to any reasonable normalcy, GLPI should eventually get their deferred rent paid via the sale of the Tropicana.  And then PENN gains itself some breathing room with the rent credits at least into the fall, if they can open up the majority of their casinos sometime in the summer, they're likely to survive, if social distancing lasts deep into the third quarter or early fourth quarter it is likely game over.  PENN might be able to raise additional cash by selling their distributed gaming business or other non-casino related assets, but following moving the Tropicana over to GLPI, essentially all their properties are leased.

But how does GLPI itself navigate the remainder of 2020?  GLPI has $5.7B of debt and pays out approximately $600MM in annual dividends to shareholders.  Below is a quick analysis on GLPI's liquidity and ability to pay their dividend.  Both Boyd and Elderado (at least pre-CZR deal) have a stronger liquidity position than PENN, but let's assume both receive similar rent forbearance arrangements and then GLPI's operating casinos are a net cash drag on the year.
As always, I'm sure I've made a few mistakes in the above, so feel free to pick it apart, but it appears that GLPI could be in a position to continue its $2.80/share dividend, which is an 11% yield at today's $25/share price. 

A lot depends on when PENN can reopen their casinos and how receptive people are to returning to gambling following both a health crisis and for many people an economic one.  Regional casinos like PENN's might hold up better than destination ones as they rely on regular customers and focus on slot machines (~93% of their gambling revenue) versus convention business travelers or high rollers.  PENN is also making an aggressive move into sports gambling with their $163MM investment for a 36% stake in sports and pop culture media company Barstool Sports in February.  Barstool has an army of loyal followers, they're truly marketing experts, and Barstool personalities pumped up the stock in the weeks following the acquisition and before coronavirus realities set in for the company.  The plan is to rebrand PENN's sports betting operation to Barstool and launch an online sports betting app, where legal, in August ahead of the NFL season.  With sports essentially cancelled for the near term, that's another blow to PENN's plans, any delay to the NFL season would be particularly painful given their investment in Barstool.

Back to GLPI, original 2020 guidance was for $1.05B in EBITDA on about an $11B enterprise value, or 10.5x, in simpler times these gaming REITs trade at 13-15x EBITDA, 14x a normalized 2021 EBITDA would make GLPI a ~$42 stock versus $25 today.  In a dream scenario, there might be an extra $1/share in the Tropicana if sold for $700MM in year two, but that feels unlikely today.  There are certainly stocks with higher upside in this market, but once the smoke clears on PENN's casinos reopening, GLPI should re-rate pretty quickly once the disaster scenario of getting the keys in the mail is off the table.  Whereas PENN clearly has more upside, but may take longer and is more exposed to how quickly the economy recovers.  Why don't I own GLPI or PENN?  Not 100% confident the dividend remains at GLPI, if its cut, might actually be the buying opportunity as other investors sell if you believe in the long term durability of their leases.  Others thoughts welcome.

Disclosure: No current position as of posting

Thursday, March 26, 2020

What I've Been Buying, Coronavirus Edition

I hope everyone is staying safe and healthy, but if you're interested, here are some thoughts on a few current positions where I've added in recent weeks, some I've bought above where we're trading today, some below.  I probably started averaging down in some of these too soon, eaten some humble pie and have slowed my activity down significantly.  I assume we'll have more opportunities as it'll take awhile for the new economic reality to work its way through our system, credit agreements will need to be amended, etc.  There will be pot holes and bankruptcies, one change from recent years is we're likely to start to see bankruptcy reorgs that are the "good business, bad balance sheet" type that have been rare lately.  Things will likely get worse, so treat this more as a watchlist than a buylist.

Howard Hughes Corporation (HHC)
I'm a long time HHC bull, my pride is hurting here at the moment, 4 of 5 of HHC's primary markets have significant near term challenges: 1) NYC is front and center of the pandemic in the U.S., likely further pushing back (I've lost count how many times now) the stabilization date of the Seaport development; 2) Houston is dealing with yet another crash in oil prices just weeks after HHC made what they describe as the "largest acquisition in the company's history" by buying Occidental Petroleum's office buildings; 3) Nevada casinos are closed indefinitely, that will have its ripple effects through the Las Vegas service based economy and slowing the development of Summerlin; 4) Similarly but maybe less impacted, Honolulu will see significantly less tourism in 2020 than it did 2019, but more importantly a fall in financial markets doesn't lead to more wealthy people purchasing vacation beach condos.  Only Columbia, MD is mostly spared due to its connection to government services jobs.

The stock has bounced back slightly, but for a while there was trading below $40 which is where it was following the spin-off from GGP almost a decade ago, I was able to add a bit there, but still find the shares incredible cheap around $50.  In early 2019, I pegged the value of the land at ~$2.35B after subtracting out land level debt using a straight line NPV approach with a 10% discount rate, sure the near term sales might be low, but the nature of raw land is long term and Nevada and Texas remain attractive states for corporate relocations due to low/no taxes and friendly regulations.  HHC has $1B in corporate level debt, so just the land portfolio is worth ~$1.35B or about $35/share, obviously this is a somewhat silly back of the envelope valuation exercise that doesn't include overhead, etc.  But sort of thinking about what has happened since the spin-off a decade ago, HHC lays out the development activity in aggregate since then in their 10-K:
We have completed the development of over 5.2 million square feet of office and retail operating properties, 2,516 multi-family units and 909 hospitality keys since 2011. Excluding land which we own, we have invested approximately $2.0 billion in these developments, which is projected to generate a 9.5% yield on cost, or $192.7 million per year of NOI upon stabilization. At today’s market cap rates, this implies value creation to our shareholders in excess of $1.0 billion. Our investment of approximately $444.9 million of cash equity in our development projects since inception, which is computed as total costs excluding land less the related construction debt, is projected to generate a 25.5% return on cash equity assuming a 5.0% cost of debt, which approximates our weighted-average cost. These investments and returns exclude condominium development as well as projects under construction such as the Seaport District. We exclude condominium developments since they do not result in recurring NOI, and we exclude projects under development due to the wider range of NOI they are expected to generate upon stabilization. In Ward Village, we have either opened or have under construction 2,697 condominium units, which have approximately 89.8% units sold as of December 31, 2019 at a targeted profit margin, excluding land costs, of 23.6% or $747.3 million.
If we go back to 2015 and early 2016 when oil collapsed from around $100, there was a lot of anxiety about Houston office space and HHC dropped from ~$150 to ~$80 in a few months, but in the aftermath of the drop, HHC's Woodlands sub-market performed fairly well, their last speculatively built office property (Three Hughes Landing) still hasn't reached stabilization 4 years later, but the bottom didn't fall out either.  Not to directly compare the two time periods, this oil route seems worse for U.S. producers as it coincides with a demand shock due to coronavirus, but Houston is a major metropolitan market (it's not say, Midland TX or OKC) and the economy will evolve over time.  The Occidental office property buy certainly looks like unfortunate timing, but the bulk of the purchase is centered in the Woodlands giving them additional control over the sub-market, the Houston Energy Corridor former OXY campus was only ~10% of the purchase price and not a significant drag if they can't sell it in a year or three.  OXY's equity is certainly in question, the company signed a 13 year sale leaseback with HHC when the transaction happened, but even a reorged OXY will need office space, and HHC recently leased some empty space in the second office tower in the Woodlands to OXY's midstream company, WES.  HHC is taking a portion of the remaining space for themselves as they move their corporate headquarters to Houston, so in reality, there isn't a lot of current vacancy in HHC's Houston offie portfolio.

I'm less worried about Ward Village in Honolulu or Summerlin in Las Vegas, Summerlin is likely to have a terrible year, coronavirus feels temporary to me when you take a longer view, whereas domestic oil production might not be viable for many years.  The Seaport has always been a bit of a clown show, it was former management's pet project, there might be more willingness now to part with it for a reasonable offer that eliminates much of the risk/earnings volatility from HHC results.

Par Pacific Holdings (PARR)
Similarly, owning a refining business is tough here, if we just had the supply shock due to the OPEC+ breakup then refiners might be sitting pretty with cheap crude and strong gasoline demand, but with everyone staying in their homes and not commuting to work or traveling, gasoline and jet fuel demand have dropped almost as much as hotel occupancy.

Quick recap, Par Pacific is part of Sam Zell's empire, he doesn't technically control the company or sit on the board, but he owns a significant stake and the PARR management team is made up of former members of his family office - Equity Investments.  Over the last several years they've bulked up their operation to include three refineries, related logistics and a growing retail presence, focusing on niche/isolated markets.  Following a small tuck-in acquisition, they're the only refining presence in Hawaii and thus exposed to their tourism market via jet fuel sales.  They've got a turnaround scheduled for later this year in Hawaii which could be a blessing in disguise as it takes supply offline in that market just when there is a lack of demand.  But in a normalized year, Par Pacific should have a current run rate of approximately $225-250MM (after the next 12 months, PARR won't have a scheduled turnaround for several years), below is the breakdown of EBITDA between their business lines and sort of a reasonable, more rational market multiple for each.  It could take us a while to get there, but management on their last call (guessing there will be a lot of cringing across many management teams when they play back their comments on Q4 earnings calls) said that PARR is "today" a $3/share free cash flow business.  Obviously it won't be this year, but that's how the owners/managers of the business think of the earnings power.
It currently trades for $7-8/share, so that looks like a silly price and maybe it is because things are really different this time.  PARR also has ~$1.5B in NOLs that should shield it from ever paying cash taxes in the foreseeable future (not that it'll be an issue this year) and a stake in a natural gas E&P, Laramie Energy, but I mentally wrote off that investment a long time ago.  Given the natural gas price environment, Laramie has no active rigs, is reportedly cash flow positive and won't require additional investment from PARR to keep it a going concern, so we can sort of sidecar it.

PARR is a small cap and thus only has a relatively short term option chain with the latest expiration being in September.  Moving up market cap, Marathon Petroleum (MPC) is a similarly constructed downstream business with refining, midstream and retail operations that has January 2022 LEAPs available.  Marathon has been under pressure from activist investor Elliott Management to abandon their conglomerate structure and separate into three businesses: 1) retail (which operates the Speedway brand of gas stations/convenience stores); 2) midstream (which is publicly traded as MPLX, MPC owns 63% of MPLX and owns the general partner); 3) and the remaining refining operations.  The company recently rejected the idea of converting MPLX into a C-Corp and spinning MPC's MPLX units out to investors, but they are still committed to separating the Speedway retail business off by year end.  Convenience store 7-Eleven's owners, Seven & i Holdings, recently scrapped a deal to buy Speedway for $22B citing coronavirus and valuation concerns.  If you assume a $15B valuation for Speedway and back out the MPLX shares and consolidated debt, the remaining refining business is something like a $9B EV (with no value given to the MPLX GP) for a ~$5B EBITDA business in normal times.  There's also reason to believe (well maybe) that MPLX is undervalued as well as they're exploring selling their gathering and processing business segment for $15B which represents 1/3 of EBITDA.  The EV of MPLX is ~$34B, and the remaining logistics and storage business should fetch a considerably higher multiple.  I threw some speculative money at out of the money calls, maybe by early 2022 the world is a little more sane, until then I don't really plan on following the day-to-day swings in MPC's share price.

Five Star Senior Living (FVE)
Five Star is debt free (besides a small mortgage on the owned facilities), has a significant net cash position for its size and receives what should be a reliable management fee off of revenue.  Even if we do see small changes in occupancy (for morbid corona related reasons), FVE isn't as exposed to the high fixed cost structure of owning the senior living properties or leasing them.  FVE shares are trading below where they sold off when it was dumped following the distribution to DHC shareholders.  While there is certainly some operational or reputation risk associated with operating senior living facilities during such a high-risk time for the elderly, if Five Star can avoid a Kirkland WA style outbreak, their business should be positioned well and is extremely cheap.  We're still dealing with swag proforma estimates from management as the new structure is only a few months old, but at the EBITDA midpoint of $25MM, that should generate somewhere in the neighborhood of $14MM in FCF for about a 6.4x multiple at the current price of $3, plus you get the owned real estate and $30+ million of cash on a $90MM market cap company.

Wyndham Hotels & Resorts (WH)
Wyndham Hotels generates sales primarily on franchise fees based on hotel revenues (93% of their business) compared to their upscale hotel brand peers like Marriott (MAR) or Hilton (HLT) which have significant hotel management businesses where they get paid a percentage of hotel level profits and employ the workforce.  During good times, the management company model is better but during bad/terrible, I'd rather have the franchise model, hotel revenues will certainly be a fraction of what they were last year, but they won't be negative like profits.  Wyndham's typical hotel is an economy or midscale hotel with limited business or convention business and less reliance on food & beverage -- convention/conference business might take a while to recover as people stay cautious on large events, and if business travel does pick back up, maybe business travelers move down in hotel segment for a period of time.  Additionally, the typical Wyndham branded hotel owner is a mom or pop who owns just the one hotel, they likely got their financing from a local bank or the SBA who might be more willing to work with them on amendments/forbearance versus a large syndicate of lenders like the larger lodging REITs.  They do have a financial covenant of 5x EBITDA that is at risk, maybe other credit folks could chime in here, but I imagine by the time the TTM month EBITDA trips that covenant we might be back on the other side and WH could work with their creditors.  I did buy a little bit of shares, but also calls as to limit my downside if things do go south with their balance sheet.

My watchlist - quick blurbs, maybe turn into full posts if I buy:
  • Exantas Capital (XAN): This is the former Resource Capital (RSO) that I owned for a couple years after C-III took over the management, cut the dividend, and reorganized the assets to a cleaner mortgage REIT.  XAN funds its assets in two ways, one is through repurchase agreements and the other is through CRE CLOs.  CRE CLOs are term financing and not mark-to-market, however the repurchase facilities are mark-to-market and Exantas failed to meet margin calls on their CMBS portfolio this week, sending the preferred and common cratering.  I'm maybe too optimistic on the commercial real estate market (HHC bull) but I think a lot of these loans get amended and Exantas might find its way out of this mess, however it won't be without some pain.  The CRE CLOs might end up tripping their OC tests and shutting off cash flows to the junior notes and equity which is owned by Exantas, so I'm on the side lines for now.  Additionally, like most CRE CLOs, these are "transitional loans" meant to fund a development project, say renovate an apartment building and move it up market, something like that.  So if the market shuts down, the borrower might not be in a financial position to complete said project or refinance into longer term financing, sticking XAN with the exposure longer than expected.
  • iStar (STAR): I want to revisit another former holding in iStar, their SAFE ground lease business has grown far larger than I imagined (although likely very overvalued), taking SAFE at market value you could make a case that the legacy business that I originally liked is very cheap.  But they do have a CRE finance arm similar to XAN, but more concentrated on construction lending in major markets (NYC and Miami IIRC) that could be a problem.  Worth looking into given the SAFE stake and the management contract associated with SAFE.
  • NexPoint Residential Trust (NXRT):  Another former REIT holding of mine, this is one that sort of got away, I'll get the exact numbers wrong but it spun off from a closed end fund at ~$11 and I sold somewhere around $22, not too far from where it is trading today at $25, a few months ago it was $52.  I love the strategy, they acquire garden style Class B apartments in the sun belt, put a little money into them to move up market a touch, maybe "B+", this investment is very high return on invested capital and then they'll sell, recycle the funds and do it all over again.  Sure their tenant base might have some credit issues in the next year, but demographic trends are still in the sun belt's favor, working class people will need reasonably affordable housing in the future, supply is relatively constrained, and this management team (it is external) has proven they can execute on their strategy.
Disclosure: I own shares of HHC, PARR, FVE, WH (and calls) and MPC 2022 LEAPs