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