Sunday, December 13, 2020

Colony Credit Real Estate: CLNY Moving Quickly, CLNC Sale Next?

Colony Credit Real Estate (CLNC) is a commercial mortgage REIT that is trading at 52% of undepreciated book value (their owned real estate is triple-net), Colony Capital (CLNY) owns 37% of the shares and is the external manager of CLNC.  CLNY is in the midst of a transition to a PE manager focused on digital infrastructures assets (they've hinted that they'll likely convert to a c-corp next year) and is quickly selling off their legacy traditional REIT assets, in recent months announcing the sale of their hospitality portfolio (a bit of a surprise versus handing over the keys) and more recently their remaining industrial assets.  CLNY CEO Marc Ganzi is everywhere, blitzing the virtual conference circuit, multiple TV appearances and selling assets left and right, the CLNY stock price has responded by roughly doubling in the last 5-6 months.  

CLNY has two large assets remaining (lots of smaller ones too), their healthcare real estate portfolio and CLNC, prior to covid they announced intentions to pursue an internalization transaction with CLNC where CLNY would presumably have gotten additional shares in CLNC as compensation for their management contract.  Post-covid, that internalization concept no longer makes sense as the bid-ask spread is too wide since CLNC trades at such a significant discount of book value, it makes it difficult for both sides to come to an agreement, CLNY would have to take a discount or CLNC shareholders would face dilution for an internalization transaction to work at current prices.

What do I think might happen?  Somewhat similar theme to MCC, most commercial REITs are externally managed and thus incentivized to grow/acquire --  I think we could see Ganzi push a sale of CLNC and CLNY's external management agreement to another commercial mREIT.  This would create a win-win for all sides, CLNY would get full immediate value for their external management contract, the buyer would acquire CLNC at a discount which benefits both its shareholders and adds AUM to the buyer's external manager, and CLNC shareholders would get a premium to current price and relieve the overhang of what might happen to CLNY's non-strategic 37% ownership position.  There is some transaction on the horizon, just a matter of the structure, here is Ganzi on the Q3 CLNY earnings call (courtesy of tikr.com):

Jade Rahmani (KBW)

Okay. Well, I applaud the swift actions the management team had taken. Definitely refreshing and very good to see the progress. I wanted to ask you about a particular -- as Tom Barrack might call it a Rubik's Cube, which is CLNC. There's an overhang in the mortgage REIT space because people are looking at commercial real estate as a long cycle to recover and potential impairments, loan losses on the credit front. So that's one thing that they have to address. Secondly, there's the liquidity that go into managing that. And finally, there is some access investment capacity. But when you look at stocks like CLNC and there's many others TRTX, LADR, to name a couple trading at 40% to 50% of book value. It means that investors are also potentially assuming an eventual dilutive capital raise.

So CLNY owns 37% of CLNC. And to me, that bodes for an opportunity, you can have CLNC buyback some of those shares at a premium to where it's trading, yet it still would be wildly accretive to its book value, wildly accretive to its earnings. It would reduce the overhang of CLNY's 37% stake because people do wonder when those shares will be liquidated, and yet it would provide CLNY with fresh capital to accelerate the digital transformation. How do you think about that as a potential option for both CLNY and CLNC to explore?

Marc Ganzi

Well, Jade, it's almost like you bugged our investment committee. So look, seriously, first and foremost, I want to applaud Mike Mazzei, Andy Witt, David Palamé. For those of you that had the chance to hear that earnings presentation, it's also another great story of transformation and execution.

When we brought Mike Mazzei on board to run that business unit, we couldn't have been more clear about what the objectives were: first and foremost, to make sure that we shored up our loans that had any issues with them, hit repo lines on 2 loans, gravitating to liquidity, and Mike's done an amazing job stabilizing that portfolio, returning cash to the balance sheet. And now that business is poised, as you heard yesterday, to play offense and be selective. And they'll play offense inside of their sandbox. And I don't get too involved in what Mike and his team does. I think they're doing a great job of executing and as one of their largest shareholders, we couldn't be happier with the progress that's happening at CLNC.

When you look at its peer group, CLNC got ahead of its issues quickly. Mike addressed those issues. He stabilized the story, he rotated the cash and now we have an enviable position where we can play offense, and we'll continue to recover book value.

You saw the shares perform well after market last night. They performed well today. We have a lot of confidence around that management team's capability. And in the meantime, we keep our options open, Jade. No option is off the table for CLNC. We've made that clear 2 quarters ago. We made it clear a quarter ago. I'll make it clear today. As we rotate to digital, if there's a good opportunity to harvest, the hard work that's been done at CLNC, we have an open ear, and we'll listen to whatever proposal comes across the table.

Seems pretty clear to me that a transaction will happen soon, given the pace of divestitures at CLNY, I would bet on Ganzi surfacing value here.  I doubt that CLNC would buy back CLNY's shares as suggested by the analyst question as it doesn't divest the external management contract, an outright sale of both CLNC and the management contract seems more likely, swift and bold, more in the Ganzi deal mold.

But let's take a look a CLNC a bit closer, I think its reasonably attractive as a standalone entity.  CLNC was created out of the threeway merger of old CLNY/NSAM/NRF, it was previously a non-traded product that was brought public in early 2018 and has since had a rough existence.  As expected with a non-traded REIT, their portfolio resembled an asset gatherer mentality without much of a cohesive strategy.  Here's what the portfolio looks like today, predictably they have a legacy segment ("LNS" = legacy non-strategic) where they house all the iffy stuff like their retail exposure.

The portfolio is a little bit of a grab bag, but back in March, Colony brought Michael Mazzei in to be the CEO of CLNC, Mazzei is an alumni of Ladder Capital (LDR, disclosure: long) where he served as the president until June 2017.  Ladder has a reputation has being a conservative credit shop, I personally like their style, so when Mazzei joined CLNC it was worth monitoring.

I've been surprised along with others, but commercial real estate loans have generally held up better than expected during the pandemic, whether the reason is modifications, interest reserve accounts, or the equity injecting additional cash into the deal -- their CLO for example hasn't experienced any credit events in the portfolio -- with a vaccine on the way, I tend to think all parties involved will continue to work together to salvage value and get to the other side.  Now is the time to get long some of these asset plays with a catalyst, the market exuberance hasn't quite made its way down to publicly traded private credit vehicles with actual real assets, but I think it eventually will.

CLNC has confidence in the future, I like when management at least acknowledges what the market is thinking, this is an external vehicle, so their options aren't ideal, but they've already hinted they'll reinstate their dividend in Q1 2021 and are making new loans today (tikr.com), you don't do that if you're on the ropes:

We also recognize that our current share price is a deep discount to our book value. This discount is also greater than that of our peer group. The current market valuation effectively implies that there are approximately $1.2 billion of future potential losses. We feel the best way to address this disconnect is by shifting the focus and momentum of the CLNC team beyond the challenges of COVID-19 and toward playing offense.

In our effort to close this gap, we are committed to continuing to protect the balance sheet while redeploying capital into new investments, building earnings and reinstituting a quarterly dividend.

In summary, while not fully out of the woods, we have accomplished many of our goals during this challenging time. We are now focused on executing our business plan to grow earnings. We have already begun to originate new loans while continuing to remain vigilant on asset, liability and cash management. The continued risks of COVID-19 can, by no means, be dismissed. However, through the efforts of the CLNC team and the support of our counterparties, CLNC is now in a position to lean forward.

CLNC does have a mix of financing, a CLO, repurchase agreements, they should have decent amount of flexibility to handle any problem loans.  Leaving out a lot here, but at 50-55% of book value, I think the setup is more important than the actual assets -- I trust Ganzi to make something positive happen here both for CLNY and CLNC.

Disclosure: I own shares of CLNC and CLNY

15 comments:

  1. THX Do you proffer CLNC or CLNY more?

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    1. I can't compare the two. CLNY at this point is a bit of a jockey bet on Ganzi executing his business plan, I can't intelligently articulate what that will look like in a few years but the upside could be pretty big. CLNC is more of a short-term event driven idea, I pretty much only plan to own this about as long as CLNY does, once a transaction takes place I'll probably move onto the next.

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    2. Are mREIT acquisitions common? I was only able to find a handful of M&A transactions (https://bit.ly/38gsYVt)

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    3. https://www.prnewswire.com/news-releases/ready-capital-and-anworth-mortgage-asset-corporation-announce-merger-transaction-301187212.html

      Here's one that was just announced. But yeah, they happen in clusters around times of distress like now, they don't happen when times are good because managers want to keep that revenue stream going. CLNY doesn't want CLNC, couldn't be clearer that its going to be gone at some point, how that happens is an open question.

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  2. The transaction was done at 76% of book value and its value has gone down since part of the payment was in the form of acquiring company stock which has declined since. Hope something similar doesn't happen with CLNC.

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  3. ANH book value at the end of September 30th was around$3.87
    Merger consideration is .1688*(RCshares= $12.54) + $0.61 cash = $2.72
    This of course change from day to day depending on the price of RC stock price, but as of now it is $2.72/$3.87 = 70% of the book value of ANH. What should we expect CLNC to be sold for? Is there a difference in the quality of portfolios between ANH and CLNC?

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    1. I wouldn't focus too hard on the ANH deal, but rather think of the parties involved in this transaction: 1) buyer's external manager: they don't care what they pay as long as it adds AUM; 2) buyer's shareholders: they want to pay below what their shares trade at on a BV/NAV basis; 3) CLNY shareholders: want a reasonable multiple on their management earnings stream but also, Ganzi wants it gone; 4) CLNC shareholders want a premium for their shares. So wherever you kind of square the 4 shareholder groups together, I'm thinking like 80% of book value? But we'll see, could be higher depending on when the deal is struck and where the buyer's shares are trading.

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    2. FYI, Anonymous, ANH stated BV at 9/30 was $3.04/sh, so deal was done at ~90% BV. Not sure where the $3.87 is from--maybe before prefs are netted out?

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    3. Anyway, it's an interesting mark. Its assets aren't as plain vanilla as some mREITs', and probably less exotic than others'; I think ~90% book, with hypothetical upside in the acquirer's equity, is pretty good for a takeout (I'd be very happy to see AAIC reach 90% book, for instance!). Still a really good environment for trading these income vehicles, in my opinion; good to see a little movement toward takeouts/value realization. In BDCs, PTMN is trying to do a roll-up, which I can't imagine will be more than middling in the long run but for now will maybe create a catalyst or two.

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  4. https://ir.clny.com/news-releases/news-release-details/colony-capital-announces-additional-legacy-asset-sales

    More asset sales at CLNY, CLNC can't be too far away.

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  5. What kind of transaction are you expecting CLNC to go through (sale, merger, etc)?

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    1. Sale/merger probably the same thing here, it’ll be another mREIT buying them in a stock for stock deal more than likely with some additional compensation to CLNY for the management contract.

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  6. MDC,

    What are your thoughts on the latest quarterly numbers? TIA.

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    1. Generally the results were as expected, the dividend initiation was good to see and should help the share price, at 50% of distributable earnings they have plenty of room to increase it as well. The CLNC call didn't sound like a company that was expecting to be sold anytime soon, but it was clear on CLNY call that the strategic process for CLNC would be done in the coming quarter or two. So my concern for CLNC (I do still own CLNY) is that whatever CLNY does it won't benefit public CLNC shareholders. Like maybe they'd sell the contract and 1/3 stake (although that's a big slug) to a new entrant in the mREIT space that would then just rebrand CLNC and CLNC shareholders wouldn't see any change. But its still trading at 60-65% of book value, there are multiple ways to win here even if the entire CLNC isn't sold/merged into another mREIT.

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