Franklin Street Properties: Office Basket, Strategic Alternatives

The second in the office REIT basket is Franklin Street Properties (FSP) (~$180MM market cap), this one might be a more direct comparable to City Office REIT (CIO) in that it owns 14 central business district (some less CBD than others) multi-tenant office buildings in the sunbelt (like CIO) but also in places like Denver and Minneapolis which have been slower to recover.  FSP has been on my radar for a long time as they've included the below language for years in their quarterly results, it's been an unofficial liquidation of sorts since the pandemic.  They've sold over $1B in property and used the proceeds to deleverage their balance sheet.

We continue to believe that the current price of our common stock does not accurately reflect the intrinsic value of our underlying real estate assets.  We will continue to seek to increase shareholder value by pursuing the sale of select properties when we believe that short-to-intermediate term valuation potential has been reached.

In May, FSP officially announced a strategic alternatives process:

“The Board of Directors is committed to maximizing value for all our shareholders,” stated George J. Carter, Chairman and CEO. "We believe that FSP's share price does not adequately reflect the underlying value of our real estate, and, accordingly, we have undertaken this strategic review process to explore opportunities to eliminate this disconnect."

We haven't seen the CIO proxy yet, but I anticipate in the background to the merger we'll see many counterparties participated in the auction (CIO mentioned conducting a comprehensive process).  FSP could be a consolation prize if you're a private equity manager with cash to burn.

FSP typically hosts a quarterly conference call to review their financial results, earnings were released today and FSP decided to skip having a call.  The market has been frustrated with the speed of this slow motion liquidation, but it appears they're finally serious about selling the remaining assets/entire company.  FSP's portfolio is only 69% leased, the office landlord business has a lot of operating leverage to it, if you (or an interested private buyer) have a strong view that leasing activity will recover then this one might be cheaper than it screens on an current NOI run-rate basis.

Franklin Street Properties is a bit of a family business, management pays themselves well, but do own 10% of the shares and to their credit have shrunk the business over the last 5 years.  The risk here is that they run a process and don't feel like they're getting fair value, continue to pay themselves handsomely and let the slow-motion liquidation continue for a few more years.

Disclosure: I own shares of FSP

Net Lease Office Properties: Office Basket, REIT Spin/Liquidation

I'm starting up an office REIT basket, last week City Office REIT (CIO) announced it was being acquired by MCME Carrell (an affiliate of Elliott Management and Morning Calm Management) for $7/share in cash, which is approximately a 10% cap rate on CIO's net operating income (85% occupancy).

It's been 5 years since the worst of the pandemic, return to office trends keep moving in the right direction.  Anecdotally, my commuter train is generally as crowded as it was pre-pandemic (excluding Fridays) and the Chicago loop seems mostly normal again.  New supply is virtually non-existent, likely will be for the foreseeable future, these things take time, but private equity seems willing to take a risk on office at these valuations.

First up, and likely the least risky of the three, is Net Lease Office Properties (NLOP) (~$500MM market cap), a well-known favorite that many other value bloggers have written up since it was spun off from W.P. Carey (WPC) (NLOP's external manager) in November 2023.  It is a vehicle designed to be a liquidation with a limited life, similar to other REIT spins of the past like Retail Value or Spirit MTA -- popular among value investors, REIT liquidation, gives me nightmares of the New York REIT (NYRT) pitch.  

But this situation has mostly de-risked, at the time of the spin, NLOP was saddled with a 14% interest rate mezzanine loan, after several initial rounds of asset sales, the mezzanine loan has now been completed paid off as of April.  That news is important because the remaining debt is all non-recourse mortgages attached to specific properties, any further asset sales on the unencumbered properties can be used to make special liquidating distributions to shareholders.  Much of the mortgage debt might end up getting extinguished via foreclosure, can almost think of those properties as call options on the office recovery.

As the name suggests, NLOP owns primarily single tenant office properties where the tenant is responsible for most of the operating expenses of the property (net lease or triple net lease).  Keeping things simple, below is a quick back of the envelope illustration of what NLOP would be approximately worth at a 10% cap rate, similar to the CIO transaction.

There's a lot more fun you can have modeling out the liquidation value here, including the cash flow from here until the final distribution, what handing back the keys means on the encumbered properties, etc.  The portfolio is 85% leased, there's one chunky property, KBS's headquarters in Houston that makes up 23% of the rent roll, but I'm generally more optimistic on Houston than others, it wasn't as impacted by covid and has a more in-person office culture than some other cities.  I think it's a manageable.

Disclosure: I finally joined the party and now own shares of NLOP

GCI Liberty: Cheap, Tax Asset, Malone Fatigue?

GCI Liberty (GLIBA/K) is back in public markets, the leading telecommunications provider in Alaska was spun off on Tuesday (7/15) from Liberty Broadband (LBRDA/K) ahead of LBRD's merger with Charter Communications (CHTR).  

Alaska is a challenging market, it has a small population with a huge unforgiving geography, partially protecting GCI from competition (although satellite providers like Starlink are a threat and starting to take some share).  GCI is primarily a broadband business (70% of revenue) which also includes 3000 miles of undersea cable connecting Alaska to the rest of the country with the remainder mostly in wireless (GCI recently discontinued their video offering).  The business was founded 45 years ago by Ron Duncan who is still the CEO today at 72 years old.  Unlike other broadband businesses, GCI is skewed towards business revenue with the big exposure to healthcare and education in rural/remote villages, many of these places only have a couple medical professionals or teachers, everyday services are provided in single rooms using video conferencing.  However, their business has challenges, much of GCI's revenue is tied to government programs (Universal Service Fund or "USF" is mid-40% of revenue) under constant scrutiny and the Alaskan economy is tied to cyclical natural resource markets like oil and mining.  Population has declined slightly over the last few years, revenue growth at GCI is likely roughly flat to inline with inflation over time.

Below is a back of the envelope valuation of GCI:

GCI Liberty is cheap compared to peers (I pulled peer multiples from CapitalIQ, didn't verify or normalize), but that's not really what caught my attention in the spin.  Unlike other Liberty entities where John Malone has stepped back from the board or agreed to eliminate his super-voting rights in negotiated mergers, here at GCI, Malone is the Chairman and will be leading capital allocation decisions.  

To steal the line of another investor I chat with, this is like the old quote that Warren Buffett has stated he believes he could achieve a 50% annual return if he were managing a smaller sum of money.  The spin was taxable to Liberty Broadband shareholders which allowed Malone to achieve setup basis on the GCI assets, resetting the depreciation tax shield (which likely also benefits from the Trump administrations recent "BBB") the value of which will be based on the first 20 days of trading, but capped at $420MM per the merger agreement with CHTR.  That value is not included in the valuation above and significant given the ~$2B enterprise value.

In the investor day presentation, John Malone comments both on the valuation and capital allocation thoughts (attribution to BamSEC):

Shane Kleinstein Liberty Media Corporation – Head of Investor Relations

I think building on that, John, we got a question from a valuation perspective, building on what Ron had said, how do you suggest investors think about appropriate multiples or valuation for this asset partially in light of the recent Cox-Charter transaction, partially in light, while GCI has strategic advantages. It is -- the dynamics have changed since it last traded publicly. So curious reviews from a valuation standpoint.

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, I would say, if you're speaking of valuation in terms of EBITDA multiple, it should trade at a premium EBITDA multiple because it's EBITDA will be fully sheltered, it has a modest debt leverage situation, so it doesn't have a lot of downside risk. It has a declining capital intensity, and therefore, its free cash flow characteristics should be superior. Now Charter is currently is trading at or around a 7 multiple EBITDA. I would think that this business should be trading at a premium to that. And if it doesn't, we've got -- we're going to have plenty of free cash flow with which to reduce equity if that opportunity presents itself, I think, the Board will be looking at returns on the free cash flow and how to deploy it.

And given the fact that we have more than enough tax shelter to shelter our own cash flow, we'll be looking opportunistically for acquisitions or investments that provides unusually high pretax returns, but that can benefit substantially from the shelter that consolidating what GCI could provide. So it's kind of an ideal core asset, around which to build some interesting incremental assets. So we certainly look forward to that. I'm hoping that it can become the beginning of a new Liberty Media and now that Liberty Media has largely gone to a single line of business focus with its spin-offs and we will have the availability, of course, of the Liberty Media management team who work for -- who will work for this enterprise under contract, providing services ranging from financial to tax accounting and public relations chain, including you.

Later on, after commenting on leverage, he goes into possible areas he'd be interested in:

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, from my point of view, Shane, I would say 3 is a pretty nice number going up for accretive acquisitions. Sometimes you'll take it up in order to -- until you get the synergies realized from combination. We would try to stay in the 3 to 3.5 range, I would think. And if we drop below that, we might take it up in some kind of a small recap and shrink the equity. But my guess is that if we look widely enough, we're going to find lots of accretive, small but accretive acquisitions in the communications sector, looking primarily at special situations, in some cases, distress, but I think that we will find opportunities to grow the business outside of Alaska with accretive small incremental acquisitions in the -- in and around the communications industry.

Capex will be a bit muted in the next 12-18 months has GCI finishes its investment cycle as part of the Alaska Plan, but following that, as a minimal cash tax payer, Malone should have a lot of flexibility to make acquisitions and use GLIBA like his "50% return PA".  Read through the spinoff docs as well, there's a lot of talk about issuing Ventures Group tracking stock in the future which could be a turnoff to many.  I haven't seen much chatter about this spinoff, there seems to be a lot of John Malone fatigue in the last 5-10 years as some of their investments have underperformed (that might be generous phrasing).  He's 84 years old, but he's an admitted deal junkie:

Shane Kleinstein Liberty Media Corporation – Head of Investor Relations

Well, John, I'll turn a related but different one to you. A question came through, what's your expected involvement in GCI and Liberty. What are the areas that you particularly expect to be taking part?

John C. Malone Liberty Broadband Corporation – CEO & Chairman of the Board

Well, I enjoy strategy, I enjoy strategizing with Ron. I love M&A. I love deals, and I love structure and so the opportunity to rebuild what some people regard as complexity and I regard it as high return investing is what I look forward to. And I think the combination of Ron and his knowledge of the business and his team with some of the young guys within Liberty Media's management structure, who are pretty good at turning over rocks so we'll have talent available to the organization that is several steps above what an organization that size would normally have available to it in terms of finance, tax structure and clearly IR and public relations. So I think we have a little bit of a supercharger when it comes to capabilities that you wouldn't normally find in a business of the size of GCI because of the involvement with Liberty, Liberty Media, me and the rolodexes that both Ron and I have been able to develop over this long period, I think, we're going to find some very interesting opportunities, which will have exceptional financial reward associated with them.

I think it's an interesting setup, cheap asset on its own, with the call-option on Malone's deal making capabilities in a smaller, less followed entity.

Disclosure: I own shares of GLIBA/K once again