Wednesday, July 21, 2021

Retail Value Inc: PR Portfolio Sale, Liquidation De-Risked

Retail Value Inc (RVI) is a retail strip center REIT that was a 2018 spin of SITE Centers (SITC, fka DDR) and has always been on my watchlist.  There were a few of these "good REIT/bad REIT" spins during that era, this is the "bad REIT" as it contained the Puerto Rican assets (along with some of their lower quality continental U.S. properties) that were largely offline due to Hurricane Marie.  From the beginning, RVI was designed to liquidate the portfolio and return capital to shareholders, over the last several years they have made slow progress on this goal by selling the continental U.S. properties piecemeal.  The question in my mind was always what value to put on the Puerto Rico portfolio?  That question has been answered which substantially de-risks the situation, last week, the company announced a bulk portfolio sale of their Puerto Rican assets for $550MM, which post-closing would leave 8 continental U.S. properties and a pile of cash.  By triangulating a few numbers, I have the remaining portfolio trading at approximately a 13% cap rate, which even for secondary/tertiary markets, seems too cheap.

Here's my back of the envelope math, feel free to point out mistakes:

Now there could be some frictional costs that I'm completely omitting, but I'm also not including any ongoing cash flow from the remaining properties, make your own assumptions there.  But here are some of my assumptions:

  • Much of the restricted cash is Hurricane Marie insurance proceeds and reserves for their CMBS financing, the insurance proceeds were to be used to rehab the properties from hurricane damage, in their Q1 10-Q they mention only needing $6MM of restricted cash to complete restoration work.  Additionally, the PR asset sale 8-K mentions that the deal doesn't include restricted cash and the CMBS will be paid off following the closing, I'm assuming the restricted cash becomes unrestricted at that point, but double check my work.
  • In the PR asset sale 8-K, the company mentions their current CMBS mortgage balance is $214.5MM, in order to get there and based on the asset sales that have closed in Q2, it appears they've spent another $20MM in cash towards the CMBS above the asset sales.
  • RVI is externally managed by SITC, the external management agreement is pretty reasonable towards RVI, there's no termination fee or incentive fee, but there is a little incentive fee built into the preferred stock that SITC is holding.  You'll see the preferred stock on the balance sheet at $190MM, but if the total disposition proceeds are above $2B, its $200MM.  I have the current total disposition at around $1.66B, and with the additional sale of the 8 remaining properties, they'll likely cross over that threshold.
  • RVI provides NOI guidance in their quarterly supplemental, it excludes assets sold to-date, they estimate $35-40MM in NOI for the continental U.S. properties.

Doing a very basic scenario analysis for what the remaining properties are worth yields anything from $26.50-$33.90/share in my estimates, versus a $25/share price today.  

Just to smell check these estimates, based on the delta between the 2021 NOI guidance given in the Q4 and Q1 supplemental, the three continental U.S. properties RVI has sold this year for a combined value of $34.4MM generate about $3MM in NOI for a 8.7% cap rate.  The Puerto Rico portfolio is being sold at an approximate 9% cap rate.  Another way to look at it, on a square foot basis, RVI will have 3.779 million square feet remaining, in 2020 they sold properties for $107/sqft, applying a similar number to the remaining portfolio would yield a value equivalent to a 9.3% cap rate.  So somewhere in that 9% range seems reasonable now that we're recovering from covid.

In summary, assuming the PR deal closes (maybe that's the biggest risk, we are in hurricane season), RVI will have no debt, approximately half their market cap in cash and only 8 properties left to sell.  I could see this taking a similar path to the MIC liquidation discussed recently, where they have back-to-back portfolio sales (although they'll probably wait until after the PR deal closes, supposed to be by end of Q3) to clean up the liquidation quickly.  Similar to MIC, not a home run, but with the situation largely de-risked, a potential ~20% upside seems pretty attractive.

Disclosure:  I own shares of RVI

Friday, July 16, 2021

CorePoint Lodging: Strategic Alternatives, Another Hotel REIT for Sale

CorePoint Lodging (CPLG) is an old friend of the blog that I've tried hard to forget, it is a hotel REIT that was spun from LaQuinta (LQ) in 2018 simultaneously with Wyndham's (WH) acquisition of the LQ franchise/management business.  It is a unique public lodging REIT in that it targets the economy and midscale select service segment (essentially all LaQuinta branded), most public REITs own upscale and luxury hotels.  Looking back at the spin, it was a garbage barge spin and performed like the moniker suggests.  

Hotel REITs are a tough asset class because as a common shareholder, you have a lot of mouths to feed ahead of you.  REITs can't be operating businesses so hotel REITs need management companies to run the hotels themselves which runs 5% of revenues, then you have the franchise fee which is another 5% of revenues, if you rely heavily on online travel agencies, that's another big hair cut. On top of that, you have a lot of fix costs and a heavy asset base with real depreciation, interest expense, etc., these aren't good businesses for public markets generally.  For those reasons, hotel REITs tend to avoid the economy and midscale segments because the average room rates are low and don't provide enough scale to justify all the overhead costs involved.  These hotels tend to be run by local mom and pop type operators who don't have the corporate costs and can avoid the management fee by operating the hotel themselves.  

CorePoint executives clearly understand this even if they don't say it explicitly and have been selling off their older, economy level hotels to individual operators at multiples that are way above where the common stock traded.  Which is sort of the opposite of what you'd expect, but if the buyer is purchasing the hotel unencumbered by the management fee, gets an SBA loan, and they get a tax depreciation shield, it starts to make some sense.  This week, CorePoint essentially put the rest of the company up for sale by announcing they are pursuing strategic alternatives.

Going back to the logic I used recently with Condor Hospitality (CDOR), another hotel REIT that is in the process of selling themselves, I came up with a very rough back of the envelope calculation for what CorePoint is currently valued at off of 2019 Hotel EBITDA (again, I understand the faults of that math, but it's what other comparable transactions are quoting as a valuation metric).  With Condor it was relatively simple because their hotel portfolio has remained constant since 2019, but CorePoint has sold a significant portion of their hotels in the last 18 months.
In CorePoint's 2019 10-K they gave us a "Comparable Hotel" EBITDA number which adjusted for those hotels that were sold or non-operational (CorePoint had some hotels hard hit by hurricanes a few years back) of $158MM.  From there, I attempt to back into what the comparable-"Comparable Hotel" 2019 EBITDA would be adjusted for all the asset sales that have taken place or are pending.  For the Q2 and pending sales, I'm using a 15x EBITDA multiple, I didn't see it directly in their filings but management mentioned 15x on their last earnings call.  From there I get about a $118MM "2019 Hotel EBITDA" number for the remaining hotels, please check my work if you're interested in the situation.  On an EV of about $1.1B, that's a 10.75% cap rate or 9.3x 2019 Hotel EBITDA, well below where the company has been selling its less attractive non-core assets and where other hotels have transacted recently.

Similar to the extended stay segment, economy and midscale hotels held up better through the pandemic and have recovered faster than urban or group oriented hotels.  Alongside their strategic alternatives announcement, CorePoint updated us on the performance of their hotels in the second quarter:
It's not an apples-to-apples comparison since CPLG has sold off a number of lower RevPAR hotels since 2019, but here's a snip from the Q2 2019 earnings release, so business is either back to 2019 levels or at least near it.
Blackstone owns 30% of CorePoint, a legacy of taking LaQuinta private in 2006 and public again in 2014.  Blackstone is obviously a big real estate investor and recently partnered with Starwood in a club deal to buy out Extended Stay America (STAY), maybe they'd do something similar here as CorePoint's hotels serve a similar segment (but clearly without the franchise business like STAY) and select-service hotels could over time look more like extended stay models with less than daily cleaning, etc., driving higher margins.

I'm a little gun-shy on putting a target price on CPLG, the stock price has run significantly and I still have mental scars from my last go around, but to a private buyer who can detach the management contract, it could be worth a decent amount more than where it is trading today at $13.75.  A 9% 2019 Hotel EBITDA (my number could be flawed) cap rate would be around $18 and would still be a lower valuation than where they've been selling their lower quality assets during a pandemic, maybe that's too high, but shouldn't be too far out of reasonableness.

Disclosure: I own shares of CPLG (and CDOR)

Tuesday, July 13, 2021

Communication Systems: Liquidation with a Speculative Kicker

Communication Systems Inc ("CSI", Ticker: JCS) is a mini conglomerate that announced earlier this year they would be selling their operating businesses and real estate assets, returning the capital to shareholders and then merging the empty public shell with privately held Pineapple Energy, a recently formed company intending to pursue a rollup of residential solar businesses.  By my estimates, the sale proceeds from the legacy businesses could roughly equal the current market cap (~$67MM or $6.75/share), with a $3.50/share special dividend coming shortly and 90% of the remaining via a contingent value right within 18 months, leaving pre-deal shareholders with a stub position in the new Pineapple Energy (ticker will switch to PEGY) as a speculative kicker.

This is a strange transaction, CSI is effectively liquidating and as part of the garage sale is getting paid in PEGY stock for the public listing "asset", it is almost a SPAC (the merger deck resembles a SPAC deck) but Pineapple is not getting any SPAC trust cash, only the PIPE they're raising alongside the closing of the deal.  In SPAC-language, CSI is almost the SPAC sponsor and getting sponsor shares in PEGY for putting the deal together and getting it public.  The current Chairman of CSI will become the Chairman of the Pineapple and the CFO is staying on board too, so the start-up Pineapple is buying some public company management infrastructure and a public currency to pursue M&A.  But it is still a bit puzzling why either side is doing this particular deal with each other, other than both companies management teams and headquarters are based in Minneapolis, maybe they run in the same social circles.

Two events have happened since the initial merger announcement:

  1. CSI sold their largest operating business unit to Lantronix (LTRX) for $25MM in cash, plus an earnout of $7MM if the business unit's revenue roughly returns back to 2019 numbers in the 12 months after the close.
  2. Pineapple announced a PIPE financing that includes convertible preferred stock, warrants and a term loan to be used to fund operations (again, pre-merger cash is being returned to CSI shareholders) and close on two M&A transactions Pineapple intends to complete concurrently with the merger deal.
Interestingly, the convertible preferred stock "will have no liquidation or dividend preference over CSI common stock and no voting rights until after converted into CSI common stock", the conversion price is $3.40/share, the PIPE investors are also receiving warrants at the same price, but this provides a reference price for the post-merger PEGY common stock of somewhere above $0 and below $3.40 (depending how you value the warrants).

With these two events announced, the total sum of the parts value is coming together:
  • Cash and investments of $21MM
  • $25MM from the sale to LTRX, plus an earnout of $7MM
  • CSI owns their corporate headquarters in Minnetoka, MN, it is on the market for $10MM and a manufacturing facility in rural MN that is leased out to the purchaser of a business they previously sold, that facility is on the market for $975k.
  • Their remaining business segment (JDL Technologies and Ecessa) has yet to be sold, the Ecessa business was purchased in 2020 for $4MM, the combined segment did $8.8MM in revenue last year.
Back of the envelope math, in a pretty bullish scenario, pre-deal CSI investors can hope for up to $6.62 back and still be left with the Pineapple Energy stub that raised capital with a $3.40 strike on the convertible preferred stock.
Feel free to stress test it on your own, maybe the earnout should be valued at zero and some discount applied to the real estate.

Why does the opportunity exist?  First, it's small and illiquid, roughly half the liquidation proceeds will be in a non-traded CVR that might not pay for 18 months.  Second, no one interested in Pineapple Energy would buy this yet.  Post merger it might catch a bid as solar is over indexed in ETFs and ESG mandates.  I know nothing about residential solar other than being frequently approached by Sunrun reps at Home Depot, but Pineapple *might* be something worthwhile.  The CEO, Kyle Udseth, seems like your prototypical founder type, he's a Stanford MBA, well spoken, did a tour of duty at McKinsey, stints at Caesars and Netflix, and has worked for several previous residential solar names before branching off on his own with Pineapple.  Public policy is pushing solar, people are building new homes, moving to warmer/sunnier climates, etc.  Maybe it actually works, maybe it's zero or maybe it just gets lucky and catches fire with retail investors, its sort of a free upside kicker in the liquidation.

  • Deal fails to close, but then it likely turns into more of a straight liquidation and your downside is somewhat protected.
  • Cash or sale proceeds that should be distributed via the CVR gets used for the new business, doesn't appear to be the intention of the transaction, but funny business does happen with CVRs.
  • My estimates are wildly off or missing something big, there shouldn't be material taxes as they do have an NOL, but there could be unforeseen expenses or the real estate assets might sell well below list price.

Disclosure: I own shares of JCS