Friday, May 13, 2022

Radius Global Infrastructure: Tower Ground Leases, Rumored Sale

Now onto something that is a little more in my historical wheelhouse.

Radius Global Infrastructure (RADI) is a holding company that owns 94% of the operating company APWireless (but I'll just refer to the company as Radius/RADI going forward).  Radius is a wireless tower ground lease company (the legal structure can vary by country, but in each case works similar to a ground lease) that purchases rent streams mostly from mom and pops, individuals or smaller investors who own the underlying real estate.  Historically, before tower REITs really took off, the wireless carriers would build their own towers and lease the land/rooftop from individuals or building owners.  Today, tower companies mostly develop and own the land under their new structures, but there's a large fragmented global market of leases for Radius to rollup.

Radius checks a few other boxes for me:

  • RADI is not a REIT and doesn't pay a dividend, although the business model would lend itself well to both, thus limiting its investor pool today.  This would be a great YieldCo (see SAFE).
  • RADI doesn't really develop new towers, but they have a global originations team that scours the market to create new leases, as a result their SG&A looks high for their current asset base (it doesn't screen particularly well), but their SG&A could arguably be separated and thought of as growth capex (HHC or INDT are semi-similar, but RADI's distinction is probably cleaner).  Their origination platform would likely be valuable to someone with access to lots of capital, for example, an alternative manager like DigitalBridge (DBRG).
  • Bloomberg recently reported that Radius was exploring strategic options including a sale.  RADI has some financial leverage and given the stability of their lease streams could trade privately for a low cap rate juicing any returns to equity holders.
A bit more about the business, stealing slides from their latest supplemental:

Radius has all the major tower companies and wireless companies as tenants, wireless infrastructure is an essential service that is only increasing in importance.  As a ground lessor, Radius is senior to the tower companies which are great businesses and have historically traded at high multiples.

In the current environment, everyone is concerned about inflation, Radius has inflation indexed escalators in 78% of their portfolio against a largely fixed rate debt capital structure, further increasing the attractiveness of their lease streams.

For a back of envelope valuation, I'm simply going to take the annualized in-place rents minus some minimal operating expenses to create an NOI for the as-is portfolio.  This portfolio should have minimal expenses other than a lockbox to cash the rent checks as there is no maintenance capex (these are structured as triple net leases).  Note the RADI share price below is my cost basis, things are moving around so much this week, don't know what the price will be when I hit publish.

The other challenging thing for RADI is all the dilutive securities.  There's also an incentive fee that is rebranded as the Series A Founder Preferred Stock dividend, I've left that out for now but may try to workout how much it would dilute any takeover offer, although I think there's enough room for error here either way.  As usual, I've probably made a few mistakes, please feel free to correct me in the comments.  But above is roughly the math if the acquirer buys Radius and fires everyone, sits back and collects the inflation-linked levered cash flows.

The piece I struggle valuing is the origination platform, but I have a feeling someone like DBRG (just as an example, any private equity manager really) would be very interested in it as they could deploy a ton of capital over time and generate pretty reliable returns.  RADI has guided to originating $400MM of new leases in 2022 at an average cap rate of 6.5% inclusive of origination SG&A and other acquisition costs.  Even using the current market implied cap rate of 5.1% above, the origination platform would create ~$110MM in additional value this year by putting the 5.1% public market valuation on the lease streams they originated for 6.5%.  RADI's management thinks they have a long runway for origination growth as they've just scratched the surface (low-mid single digit penetration) of this fragmented market.  Any value prescribed to the origination platform would be above and beyond my simple math in the Excel screenshot.

Interestingly, during the Q1 DBRG conference call, DBRG CEO Marc Ganzi said the below with regards to the digital infrastructure M&A environment (transcript from bamsec):

We do see public multiples retreating in some of these different data center businesses or fiber businesses or ground lease businesses. There's been a pretty sizable contraction and the window is beginning to open where we see opportunity. And I think by being once again by being ultimately a good steward of the balance sheet and being prudent in how we deployed that balance sheet last year, we've taken our shots where we have good ball control, and we've taken our shots that are candidly going to be accretive

And there's reason to take Ganzi's comments quite literally as DigitalBridge made a splashy deal this week in one of the three categories he called out by purchasing data center provider Switch (SWCH) for $11B.

I've bought some RADI common this week and also supplemented my position with some Aug $15 call options.  Similar to other ideas over the years, I like call options here, there's no reason to really think that RADI's business is deteriorating alongside the overall market, their leases are inflation linked and structurally very senior in an infrastructure like underlying asset.  There's financial leverage, low cap rates and an origination platform that could be valuable to someone, all of which could lead to a big takeout premium if they strike a deal.

Disclosure: I own shares of RADI (plus DBRG, HHC, INDT) and call options on RADI

Friday, May 6, 2022

Argo Group International: New Activist Pressure, Pursuing a Sale

This will be a brief post and not the most exciting idea given the current chaotic market backdrop, but I wanted to throw something out there as it has been a while since hitting publish. I've mostly just been sitting tight, waiting for events to play out and adding to a few current positions during this downturn.  I also don't have much experience with insurance companies so be easy on me in the comment section.  

Argo Group International (ARGO) is a specialty insurer (~$1.5B market cap) that first popped up on my radar screen in 2019 when it faced a proxy contest from Voce Capital, their largest shareholder (9-10%), which eventually added three representatives to the board.  Voce put out an entertaining deck that outlined the now ex-CEO's lavish lifestyle (corporate penthouses, art collection, sailing sponsorships, private jets, etc.) that was essentially being expensed through Argo.  

In the ~2 years since Voce refreshed the board and the ex-CEO resigned, Argo has gone about shedding unprofitable or volatile business lines to highlight the strong U.S. focused specialty insurance business. 

The crown jewel is their excess and surplus business line that focuses on risks that standard insurance markets are unwilling or unable to underwrite.  This the non-commoditized, less regulated corner of the insurance market and thus should be more profitable.  The transformation goal has been to uncover and highlight this business: 

However, the perceived slow speed of the transition and a surprise reserve adjustment in February brought forward another activist pushing for board representation in Capital Returns Management, an insurance focused hedge fund.  Capital Returns has also insisted the company put itself up for a sale and the board agreed last week to run a strategic alternatives process which includes exploring a sale of the company.  While, Capital Returns argues the board doesn't have skin in the game (in aggregate they own ~1% of the company), there are three Voce representatives on the board and they've moved the business down Voce's suggested path.  My guess is Voce is in agreement that now is a good time to pursue a sale and the board is unlikely to resist a reasonable offer.  In short, this may go from semi-hostile to friendly, the verbiage from the recent earnings call seems to imply that as well:

Thomas A. Bradley Argo Group International Holdings, Ltd. – Chairman of the Board & Acting CEO

Thank you, Greg, and thank you to everybody for joining us today. Before I jump into our results for the quarter, I'd like to take a moment to discuss our announcement last week. Over the last year, Argo has instituted a number of substantive strategic initiatives, actions that we believe have positioned the company for a clear and consistent long-term path to stable growth and profitability. The Board of Directors and management team, however, do not believe these initiatives are adequately reflected in the company's current market valuation.

After much thoughtful and deliberate discussion and analysis, our Board with the assistance of our advisers has initiated an exploration of potential strategic alternatives. In this review process, our objective is simple: to maximize the value of the company's strategy and its considerable long-term prospects for the benefit of all shareholders. To that end, the Board will consider a wide range of options for the company, including, among other things, a potential sale, merger or other strategic transaction.

What would be a reasonable valuation in a sale?  Again, I've only looked seriously at 1-2 insurance companies here in the last decade.  But below is a list of U.S. based peers that I took from Capital Returns' proxy, and the data is from TIKR.
This is admittedly rudimentary, but for a business that's proforma combined ratio should be in the low 90s, a 1.5x book valuation seems reasonable for a strategic buyer?  Kinsale Capital (KNSL) is a pure play excess and surplus insurer which trades for a high valuation, there's a KNSL short thesis on VIC worth reading, giving a little bit of comfort that other players will be interested in ARGO and that it should trade at a reasonable premium to book.

The sale process could take some time, maybe we hear something in 5-7 months, so again, there are likely more immediate/actionable opportunities in the current market dislocation, but keep this one on the watchlist.

Disclosure: I own shares of ARGO