CMCT has a strange origin story for a public REIT, it began life in 2005 as a private equity real estate fund diversified across office, multi-family and hotel. In 2014, as the fund's maturity was coming up, it was reverse merged into a small mREIT ("PMC Commercial Trust") that made SBA loans (CMCT oddly still makes SBA loans in this legacy segment), with the PE fund owning well over 90% of the proforma entity, but only the non-PE investor shares traded publicly creating this odd stub. Cynically, CIM took a limited life fee stream and turned it into a permanent one at the detriment of their investors as the shares have failed to trade close to NAV since the reverse merger. In the meantime, CIM has sold the majority of assets within CMCT in a few different slugs and then returned capital to investors either through a buyback or a big special dividend that was issued in 2019. Notably, those asset sales were done near their published NAVs at the time. So here we are now, a subscale externally managed REIT with long suffering shareholders that has limited options to raise capital to grow, sort of stuck in no man's land heading into a post-covid world.
Here are the real estate assets today:
Again, the portfolio is heavy on Oakland and LA. In Oakland, they own the Ordway Building (1 Kaiser Plaza) which is primarily leased by Kaiser (30% of CMCT's overall rent roll). Kaiser previously announced they would build a new headquarters in Oakland and consolidate their real estate foot print (presumably exiting CMCT's asset) but recently they cancelled those plans in light of the pandemic, so potentially Kaiser could extend their lease. If not, market rents pre-pandemic were a decent bit higher than in place rents, we'll see how things shake out in the Bay Area, but Oakland could cool off significantly as San Francisco office becomes cheaper and reduces the spill over into the more affordable Oakland market. Additionally, they do own a parking lot next door, which they've been marketing as a build-to-suit, but presumably new office development is off the table for several years, my guess is it remains a surface lot for the foreseeable future.
The other chunky asset of concern is the Sheraton Grand Hotel in downtown Sacramento. CIM acquired the hotel in 2009, it sits next to the convention center in Sacramento which is finishing up a renovation and expansion project, the convention center is scheduled to open in February. Pre-covid, CMCT was planning to invest $26MM to renovate the hotel, but those plans have been put on hold. CMCT also owns another parking lot across the street that they suggest is an additional development site for either a hotel or multi-family tower. Located in a state capital and positioned next to the convention center, I can see a path where this hotel fully recovers. Downtown Sacramento has seen a considerable amount of development recently and there are a number of hotels that are in the pipeline, one is even considering breaking ground soon, signaling demand or at least the expectation of a recovery in the market. The hotel is still cash flow negative, in October (last data point) it only averaged a 29% occupancy rate, and isn't expected to cross the break even line during the first half of 2021.
In LA they own several clusters of assets, LA is CIM Group's backyard. I don't have much to add here, the one asset that is only 21% occupied was previously earmarked for a significant repositioning, but that's been put on hold as well. The below slide management puts out also shows all of the properties CIM has exited over the years, clearly you can see that they're one of the major players in the LA market providing some comfort around this piece of the portfolio.
The other assets include an office complex in Austin that was just leased up and a small loft style office property in San Francisco. And as mentioned earlier, they oddly still operate the SBA lender business which is a legacy from the reverse merger. Making SBA 7(a) loans is a fairly good business, a portion of the loan is guaranteed by the government, SBA loan originators are able to sell that guaranteed portion into the secondary market and since it is guaranteed by the U.S. government, originators are able to sell those portions at a premium. They're then left with servicing rights and the unguaranteed portion of the loan, which most lenders retain. The one red flag with CMCT's SBA business, the portfolio is basically a pure player lender to franchisees of economy and midscale franchised hotels (think brands under the WH or CHH flags). They also have PPP loans they've extended to their borrowers that will likely be fully forgiven and paid by the SBA to CMCT. I tend to think the economy hotels make it through covid, but its worth flagging that there is risk in this asset.
So those are the assets, the capital structure is a bit odd here, it's heavy on preferred shares, which about half of which are continuously offered through their RIA channel and are not publicly traded. I took the 2019 proforma NOI from the Lionbridge letter and backed into what cap rate the market is putting on their assets, approximately 6.7% which feels high to me.
Will CIM Group cave to activist pressure?
CIM Group was co-founded by Richard Ressler (Chairman of CMCT, also Chairman and former CEO of JCOM), Avi Shemesh and Shaul Kuba in 1994. Today they manage just under $30B in assets, about $1B of which is CMCT (at their stale valuation) and they also have a significant non-publicly traded REIT business after their purchase of Cole Capital in 2018. I bring that up because they recently merged a few of their private REITs, potentially in preparation to list them publicly, might be stretch but that vehicle is much larger than CMCT and they wouldn't want to damage their reputation and limit that REIT's growth in future (assuming CIM agrees that CMCT failed in becoming a growth platform).
The management agreement at CMCT is a bit non-standard for an external REIT, it was rolled over from the original PE fund and wasn't revised in the merger:
- The management fee is tiered with breaks as CMCT gets larger, but instead of getting bigger, it has only gotten smaller as a public entity, and more problematically the fee is based off of the asset value in the NAV calculation. The stock has never traded anywhere near NAV and clearly NAV is subjective and manipulatable in their favor. Additionally they have typical expense reimbursement provisions, read through the activist letters for more detail.
- It is a perpetual term contract, "and shall remain in full force and effect until the Partnership is dissolved, this Agreement is required to be (or is automatically) terminated pursuant to the terms of the Partnership Agreement or the Partnership and the Adviser otherwise mutually agree" -- I'm guessing this is the angle of the activists, take over the board and then "dissolve" the partnership entity through a liquidation. But not entirely sure a proxy win for the activists is needed here.
- One benefit of rolling over the original management contract, it doesn't appear to have a termination fee which most externally managed REITs include, making it more attractive for activists to get in here and attempt to remove the manager.
What transpired over the next few years bore little resemblance to CIM’s originally stated growth objectives for CMCT. In 2017, CMCT sold over $1 billion in assets and repurchased a similar amount of CMCT stock owned by the private fund. In its public communications, CMCT depicted these corporate actions as the result of a regular evaluation of its business and prudent management. Based on our firsthand discussions with CIM Urban REIT investors, however, we believe these sales were the result of extreme pressure from its fund investors, who were voicing displeasure for the public vehicle. In other words, only when it was clear that the REIT strategy had flopped, and under intense pressure from its pension-fund clients, did CMCT begin selling property and returning capital to investors.
Rather than rightfully completing the sale of its portfolio once and for all and returning the remaining value to its investors in cash dividends, CIM dug in its heels. In 2018, the company announced a "Program to Unlock Embedded Value in Our Portfolio and Improve Trading Liquidity in our Common Stock.” At the time, CMCT was trading at a nearly 40% discount to NAV. This program contemplated another $1 billion in asset sales, or roughly half of the remaining portfolio at the time. The net proceeds were distributed to shareholders, but again, instead of completing a cash liquidation, the private comingled fund was dissolved via a distribution of CMCT shares to its partners. The result was a more structurally flawed company with even less scale. Upon the distribution of CMCT shares, the partners would own over 95% of this deeply flawed and obscure REIT’s shares.
In its public messaging CMCT portrays its asset-sale programs as discretionary capital allocation moves made in response to strong markets and emblematic of CIM’s willingness to return capital to shareholders. Again, based on firsthand accounts from CIM’s partners, we believe that assertion is misleading. We understand the asset sales and return of capital were being demanded by the partners, according to some accounts, under threat of litigation and were not what CIM Group was otherwise inclined to do.
Contrary to what CIM representatives portrayed to prospective investors, what awaited the market after executing the plan to “unlock value” and “increase liquidity” was an ownership base comprising almost entirely legacy fund investors whose moods we understand generally ranged from frustrated to incensed at CIM’s refusal to completely liquidate the company for cash. In the aftermath of the distribution, the shares were soon trading at a nearly 50% discount to published NAV, wider than when the “Program to Unlock Embedded Value” was announced. They would remain in that vicinity for months before they further collapsed in the COVID-related market sell-off.
Disclosure: I own shares of CMCT
Any idea why it popped?ReplyDelete
Nope, maybe some misinterpreted the management fee being paid in preferred shares as an insider buy.Delete
seems like the two activist funds would be better served to work together with a merged list of director candidates. thoughts?ReplyDelete
Yeah, that would be make sense, although it is still probably an uphill battle to replace the board. I think the more likely outcome is some kind of settlement, announcement of strategic alternatives to either sell to another REIT or liquidate the company.Delete
To be clear, with the recent pop to $16/share, which upside do you see from here? Your calculation shows a market cap of $240M at the 6,7% cap rate, which (at least according to Seeking Alpha) we've now reached? Do you expect the recovery to the old NAV (~20-22$/share) if they manage to liquidate?ReplyDelete
The market is pricing in a 6.7% cap rate (on 2019 NOI), I just backed into that using today’s market cap, not saying $240MM is the upside. Correct, my guess for the liquidated value would be somewhere around $20-22, probably closer to $20 in a liquidation and $22 in a sale (fewer costs involved).Delete
This is an interesting idea. I thought this was the company that Arquitos Capital was referring to in their letter but I don't think it is.ReplyDelete
Any idea which real estate company he's referring to?
Sounds like NTP, but just a guessDelete
Think you're right. Gonna have to dig in tonight. ThanksDelete
Hey MDC - have you looked at NTP? Seems like a lot of value to me :)ReplyDelete
Thanks for pointing it out, like you said on a recent podcast, I'm one of those that "bought a little in my PA" but was too sheepish to write it up. Congrats on the big legal win today.Delete
Planet Micro Cap, episode 168 "The Investors Roundtable #31: Nam Tai $NTP, Crypto and is Traditional Value Investing Dead"Delete
Those are heavy fees they are paying with shareholder's money to raise capital.ReplyDelete
Yeah - At least they stopped issuing common stock to pay the management fee versus preferred stock, but yeah, it's not great obviously but they've chosen to conserve cash during the pandemic.Delete
8-K listing their new NAV of $22.00-$22.50ReplyDelete
Any updated thoughts on this? Seems like it has been quiet in terms of any discussions between activists and the company. Also seems weird that the company hasn't filed a proxy statement for the annual meeting yet. Last year the proxy was filed on April 10 for an annual meeting on May 7.ReplyDelete
The 10-Q that just came out on May 10 says the company expects to hold the annual meeting in Q4 2021. Maybe that is a good sign that they are working on something?
No real updated thoughts, I still like it, especially at these prices. You could be right on the delay of the annual meeting, or it could just be either waiting for some additional office recovery/return to work before they're put to the fire. Or just wanting to wait until it can be done in person? I'm not sure either.Delete
Do you have a link to the estimated NAV from 12/31/19?ReplyDelete
I found the 12/31/19 estimated NAV source:ReplyDelete
Lionbridge's proxy out, proposing Winthrop to take over the management. Some nightmares of a NYRT repeat in my head, but hopefully CIM is in the process of selling the company to avoid further reputational damage.
They just announced intention to raise $137 million through a rights offering to shareholders as of June 11. What a joke. They are going to double the share count when you have unaddressed concerns from two activists groups and with the annual meeting inexplicably pushed back to Q4. They are straight up abusing shareholders. Would look for these activists to come back hard on them given there is not enough liquidity to get out and they are not going to want to double their positions in this piece of shit governance structure.
I agree with the sentiment, pretty BS. Double the share count at 40% of NAV, increase their own management fees as a result under the guise that there a lot of acquisition opportunities out there, and also essentially backstop it by saying they'll oversubscribe to their rights, blocks the activists. Very disappointed, a bit surprised the shares aren't down more today, proforma NAV is probably $15-16, although its derisked from a balance sheet perspective.Delete
What am I missing? If one were to buy into the idea that NAV around $20, it would be a great opportunity to be able to buy additional shares at $9.25. The stock price should move up, shouldn't it? I am actually skeptical of the $20 figure. Weren't the shares trading in $14-$15 range before the pandemic. Pandemic induced work from home secular changes, definitely impaired commercial real-estate in the Bay Area. By how much is anybody's guess. Getting back to $14-$15 range again should be a challenge. How can they realize $20 value if they try to liquidate. So, if you assume $11-12 as fair value rather than $20, opportunity to buy at $9.25 may not be a bad thing.ReplyDelete
Because $22 NAV (12/31/20 number) is based on the current share count, by doubling the share count at $9.25, you dilute existing shares. The basic math is you average $22 and $9.25 since the raise is almost exactly the current share count. Rights offerings can be opportunities, but it usually revolves around an announced acquisition, the company needs to raise capital for a deal, fairest way can be to do a rights offering (if their are NOLs, a rights offering protects those), but here there's no announced deal, its just a capital raise and sort of a disguised way of management giving themselves more shares. You design it in a such a way that outsiders are unlikely to fully participate, CIM group will likely end up increasing their share of the company through the rights where if they just did a private secondary to themselves, it wouldn't be seen as fair (see the situation at NTP). But here they're out in the open about it, allowing others to participate, but knowing many won't.Delete
Yeah IMO the issue is that the structure they have set up confiscates value from common shareholders via the above market management fee/preferred equity. That structure is why the shares trade at such a large discount to NAV, in addition to management being incentivized to high-ball NAV to capture a larger management fee. They are now giving common shareholders a choice to either 1) put additional money into this structure where management will continue to extract value from you or 2) sit out on the rights offering and let yourself be diluted, resulting in additional value accruing to the management team via the oversubscription. This investment thesis relied upon breaking up this unfair management structure so that the value of the underlying assets would accrue to the common rather than management. Management is showing via this rights offering that they are willing to further entrench themselves and screw the common for their own benefit.Delete
I haven't done anything yet with my shares, might wait for an activist to respond, but probably should sell now that the "management will cave and sell to protect their reputation" thesis is broken.
Sure, one would be diluted if they don't exercise the rights. But assuming that you do and activists should also, then the value of your shares goes up. You might be right that the intention behind rights offering might hint at entrenchment. I will wait and see.Delete
Rights do provide some good trading opportunities, post rights stocks tend to go up after the selling pressure abates. But the value of the shares should only go up by the amount you oversubscribe to versus others who choose not to participate, their dilution is your gain.Delete
It's even worse than I thought. Didn't realize activists would substantially be blocked from participating in the oversubscription given they already own 6% and there is a 6.25% ownership limitation. Will be interesting to see if they can hold up the rights offering based on the violation they identified. I do find myself more interested in buying back in with the stock down 10% today.. but difficult to know how this will shake out.
Yeah, pretty wild that they're restricted from participating. Makes me wonder how much CMCT is actually going to raise in the offering? Its not a tradeable right as far as I can tell, so I imagine quite a few investors won't participate. I'm still following closely, did sell my shares as I mentioned lower in the comments, hoping to be able to wait 31 days to get the tax loss, but things could get very interesting/cheap here before then. You also have the Russell rebalance as CMCT is getting booted.Delete
I imagine they will still raise close to the full amount? I would expect the management team to fully participate in any oversubscription available and materially increase their ownership %. Agree that the rights are not transferable/tradeable so there will be a large amount of investors that do not participate, which will leave a large amount available for oversubscription.Delete
Maybe they do, putting myself in CIM's shoes, clearly the management contract is more important to them than their investment in CMCT. So my guess is they poll investors they know are friendly to them, and do the math to see how much they need to oversubscribe to cement their control.Delete
I agree, I sold my shares. Wouldn't be surprised to see the shares drift lower if investors sell to raise cash to participate in the offering, and part of me thinks there could be an opportunity there. But I just think they've shown to be so value destructive it's not worth it to stick around and hope they change course while they continue to extract value. Also considered waiting around for activist response but doesn't seem like the market has been very responsive to their past letters and not sure what options they really have at this point other than to threaten litigation?ReplyDelete
I sold my shares today, had to sleep on it a few days, but just don't want to put more capital into this vehicle given CIM's apparent anti-shareholder stance. Pretty terrible governance in my mind that the board would allow the management team to double the sharecount at 40% of NAV. We also have the Russell reconstitution coming up, CMCT might get knocked out, so we could see some forced selling around the reconstitution and the rights offering. Could be interesting again after those events.ReplyDelete
What is the Russell reconstitution?Delete
The Russell 2000/3000 index updates its holdings every June, CMCT fell out of the index this year, so there might be some selling pressure later this month with index funds have to sell.Delete
Got it thanks.Delete
What is it about being a Maryland corporation that makes it difficult to unseat an external manager?ReplyDelete
I believe the voting is a little different, majority of shares versus votes cast sort of thing. All external REITs like Maryland law, but i don’t know the full legal background to thatDelete
At the current price of $7.71, the stock looks dirt cheap. Any thoughts?ReplyDelete
I agree, I'm back in it a little higher than here, but I have the proforma NAV at $17.45, even with the worst management and governance, 44% of NAV is too cheap. That's like BBX Capital or Biglari discounts, maybe appropriate, but the assets/business here are simpler and shouldn't get that kind of discount. With the rights offering, the balance sheet is also derisked significantly. But hard to what a catalyst is at this point, other than valuation.Delete
Is some big lease going to be cancelled or something? What's with this stock?ReplyDelete
Pretty incredible value destruction, but CIM is buying via one of their other funds:Delete
I'm bagholding a small position, at least until year end tax loss harvesting time.