Braemar Hotels & Resorts: Internalizing Management

Throwing together a quick note on Braemar Hotels & Resorts (BHR) (~$180MM market cap) before I start a busy Friday, forgive me if there are any glaring mistakes, I'll come back and fix them over the weekend.  Today, BHR announced the conclusion of their strategic review, originally it was a sale process, but now the luxury hotel REIT is going to internalize management and distance itself from its external manager, Ashford Inc.  My first take is this move is designed to get Ashford Inc its $480MM termination fee without being subject to a shareholder vote (10% holder Al Shams Investments Ltd has been vocal in trying to block this payment to Monty Bennett) that would come with a full sale of the company.  BHR recently announced the sale of 3 hotels for a total of $437.5MM (12.5x hotel EBITDA by my math) that along with cash on the balance sheet, should be sufficient to payoff Monty.  Ashford directors are resigning, the board will be refreshed, and the new REIT will be free to pursue life without external management conflicts.

Post-internalization, this will be a pretty small subscale REIT that should attract takeover attention.  Hotel REITs have been performing exceptionally this year, the top of the K-shaped economy is doing well, especially with all the Mag7 stock comp and AI IPO money hitting the upper class brokerage accounts.  Below is my back of envelope of what BHR might fetch in a sale (so its not including corporate overhead as a standalone to be clear):

I own too much of this to begin with, but depending on where it trades today, could be provide an interesting entry point for those on the sideline now that Ashford will be out of the picture.  Some of these properties are exceptional assets that any number of other REITs or private investors would gladly scoop up.

Disclosure: I own shares of BHR

Braemar Hotels & Resorts: HST Four Seasons Sale, Updated Thoughts

This week, Host Hotels & Resorts (HST) (the grand daddy of lodging REITs) announced the sale of two luxury properties, the Four Seasons Resort Orlando and the Four Seasons Jackson Hole for a total of $1.1B ($1.9MM/key):

The multiples provide a pretty good comp for Braemar Hotels & Resorts (BHR):

HST management was almost glowing at the current depth of buyers in the luxury market:

Michael Joseph Bellisario Robert W. Baird & Co. Incorporated, Research Division – Director and Senior Research Analyst

Jim, on the Four Seasons sales, certainly great execution there and you're proving out value. So of two parts here. One, how deep is that buyer pool today? And then two, can you, and next maybe, would you sell more of your top assets? Or what's the outlook and thinking around more high-value dispositions going forward?

 James F. Risoleo Host Hotels & Resorts, Inc. – President, CEO & Director

So are there other opportunities to maximize value within the portfolio? I think there is, we'll be opportunistic. The buyer pool for these types of assets is, I think, a lot deeper than people realize. There are a lot of sovereigns out there who are very interested in luxury hotels. There are high net worth individuals who are interested in luxury properties as well. And there are a couple of big private equity firms that have a lot of capital that have been sitting on the sidelines waiting to -- waiting for the inflection point to jump back into the market. And we're hopeful that this is the inflection point that we can prove out that there is value here, value to be created, and we're certainly hopeful that we're going to get the read through and see some multiple expansion as a result of not only this decision, but all the capital allocation decisions that we've made over the last 9 years.

Updating my math from September, and removing the Cameo Beverly Hills as it has undergone an extensive renovation/re-branding which has caused it to be NOI/EBITDA negative over the last twelve months: 

Not all of BHR's properties are luxury, about 25% of the portfolio is urban, so a full 15x hotel level EBITDA takeout is unlikely, but given how levered the capital structure with the termination fee is to the equity stub, there's a lot of potential upside here if BHR can get a similar transaction execution.  HST also called out the two sold hotels will need significant capex in the next few years, potentially suppressing the transaction multiple.  An advantage of the external management structure at BHR is Ashford gets paid as the project manager for any construction projects and the last twelve months of construction management fees are capitalized in the termination payment.  Ashford is incentivized to do renovation projects and following the completion of 3 hotel refurbishments in 2025, the portfolio should be pretty clean for a new owner, maybe getting us closer to 15x?

Another note of interest, BHR changed how they're handling preferred dividends to prepare for a sale, seems like they should be pretty close to wrapping this thing up.  I exercised my $2.50 call options that expired in January and have added to my position since.  I'm also up for any comments or thoughts on AHT, which recently announced a similar strategic alternatives process (is that different than BHR's "sale process"?) although they haven't announced a termination payment agreement with Ashford as BHR did.

Disclosure: I own shares of BHR and April $2.50 call options

Braemar Hotels & Resort: Gross Asset Management Contract, Initiated Sales Process

It's probably a sign of the times, have to dip in quality to find some ideas and this pitch makes me throw up a little in my mouth. 

Braemar Hotels & Resorts (BHR) (~$200MM market cap, ~$2.1B enterprise value) is a luxury hotel REIT that was formerly known as Ashford Prime, a spin of Ashford Hospitality Trust (AHT) in 2013.  BHR is externally managed by Ashford Inc (formerly AINC, went private via a reverse/forward split last year), the creation of the infamous Monty Bennett.  Hotel REITs are a challenging business because they need to outsource the hotel management function to a third party to maintain REIT status, then also pay for the franchise flag, throw on top of that an egregious external asset management contract and BHR never had a chance.  The only reason these external Ashford hotel REITs exist is because they were all originally under one roof before AINC was spun from AHT.  I don't think this structure would have gotten public otherwise.

Again, skipping a lot of history here, there has been numerous activists at BHR trying various ways to remove Ashford from an otherwise healthy portfolio of luxury hotels.  Finally, on August 26th, the REIT officially waived the white flag and announced the initiation of a sale process.

In a typical external REIT management agreement, there might be a 3x termination fee, not so with BHR, Ashford has negotiated a "discount" to their termination fee with the board to facilitate a sale:

Their termination fee is 12x PLUS another 20% on top of that, again truly gross and no way AINC would have come public without being a spinout of its blood sucking host AHT.  Bennett would later steal AINC by issuing himself preferred stock and draining all value from minority AINC shareholders.  While I just wrote up not being sure about the incentives in the TURN/MCLI deal, here they're squarely in our face that Ashford only cares about themselves and views this as an opportune time to get 14-15 years worth of management fees upfront.

However, I still think there might be a trade here, albeit a very risky one.  This sale process rhymes a bit with Bluerock Residential Growth REIT (fka BRG, now BHM) where you had an externally managed REIT with a messy balance sheet that effectively made the equity a stub.  Any positive surprise in the sales process produced exceptional returns for the stub.  Below is my quick back of the envelope math on the potential outcomes of a BHR sale based on various cap rates:

Most of the value in the portfolio is in a handful of luxury hotels, 4 under the Ritz-Carlton flag (Lake Tahoe, Puerto Rico, Sarasota and St. Thomas), 1 under the Four Seasons (Scottsdale).  Luxury hotels have continued to perform well through the covid bullwhip with some luxury hotels trading hands well within the range above.  I've also included the $25MM termination fee to rid the buyer of Remington, Ashford's hotel management arm, plus the potential for the preferred stock to convert to common above $4.39/share.  Again, it feels a little gross to own this one, Ashford is really incentivized to only get a price above their termination fee so we're counting on the independent board members (one new board member already came out publicly they were unaware of the termination fee negotiation) to keep the process honest.  But I think it's an interesting bet in small size.

Disclosure: I own shares of BHR plus a few call options

Ashford Inc: New Trend of "Externalizing" Management

Ashford Inc (AINC) is the asset management spinoff of Ashford Hospitality Trust (AHT) that a reader recently alerted me to, so I did some digging and while I don't think it's particularly appealing at current levels, it could provide some insight into similar upcoming spins/breakups at American Capital Ltd (ACAS) and Prospect Capital (PSEC), both BDCs, which are also spinning off their asset management businesses.  Most corporate governance groups and investors would prefer to see REIT/BDCs internalize management, but now there is this new trend to externalize management with asset management spinoffs, not something that happens at market bottoms.  External asset managers have a number of potential conflicts with the entities they manage, what's good for AINC shareholders (AUM growth) may not be best for AHT shareholders if they end up over paying for growth or issuing shares/debt at less than ideal levels.

In November 2013, AHT spun-off its luxury hotels into a separate entity Ashford Hospitality Prime (AHP) in an effort to obtain a premium valuation and a lower cost of capital.  As part of the AHP spinoff, AHP entered into an external management agreement with a subsidiary of AHT which laid the groundwork for the AINC asset management spinoff.  Ashford Inc (AINC) was then spun-off on 11/12/14 with an odd 1 share of AINC for every 87 shares of AHT ratio, it started trading in the mid-$40 and quickly traded all the way up to over $130 (quick triple for some) a share with CEO Monty Bennett buying in the open market along the way.  It's now trading around $93.

Ashford Inc currently manages the Ashford complex's two REITs (AHT & AHP) on 20 year contracts and is in the process of setting up a real estate focused hedge fund under the Ashford Investment Management banner which will be 40% owned by Monty Bennett and one of his lieutenants.  They're also interested in a few future growth platforms as shown below:

Asset management companies are of course great businesses, they have substantial operating leverage with minimal capital expenditures, a small increase in AUM can disproportionately increase earnings in a hurry.  What makes Ashford more attractive than other small cap asset managers is their capital is essentially permanent, while their market caps can certainly decrease, Ashford's REITs won't be subject to outflows like a traditional mutual fund manager in a market decline.

The spinoff wasn't without some controversy, labor union UNITE HERE staged some opposition to the transaction by creating a website (http://www.unlock-ashford.org/) outlining some of the real or perceived conflicts of interest created by the structure.  Ashford also instituted a poison pill that expires in March and has a staggered board, both anti-shareholder friendly, which was picked up by the Wall Street Journal on Monday. 

Ashford Hospitality Trust (AHT) & Ashford Hospitality Prime (AHP)
Ashford Inc is really a leveraged bet on the growth (and to an extent the performance) of both AHT and AHP as Ashford will be paid a 70bp base fee on the total enterprise value (but including cash) and an incentive fee based on the relative stock performance versus a peer group for both entities (determined annually but paid over three years), so it makes sense to analyze each briefly.

AHT considers itself an opportunistic hotel investor, having a wide mandate to invest across sector subclasses and across the capital structure.  It also utilizes significantly more leverage (both debt and preferred stock) than the average REIT, and is quick to refinance non-recourse mortgages to raise cash as it did recently.  Management likes to tout their 19% insider ownership at AHT as a method of aligning shareholder interests, and there seems to be some truth to that as AHT was savvy during the financial crisis and was able to repurchase a substantial amount of their float at advantageous valuations.  Including cash, the enterprise value of AHT is around $4.2B.

AHP on the other hand is marketed as the lower risk, higher quality portfolio compared to AHT.  At the time of the AHP spinoff they articulated a clear strategy of targeting hotels with RevPar (revenue per available room) of at least two times the national average and located in major gateway and resort market.  AHP will also have a  lower debt profile than AHT, with a target of 5x EBITDA by the end of 2015 and going forward.   Ashford also recently announced a share repurchase plan at AHP, again something you wouldn't expect if you're extremely cynical about external management.  They plan to sell one of their hotels and buy back shares, essentially reversing the private/public arbitrage that REITs generally exploit.  Including cash, the enterprise value of AHP is around $1.4B.

I didn't spend too much time on the above table (so don't trust every number), but compared to peers, both look slightly undervalued on a relative basis and not particularly expensive on an absolute basis.  However, Hotel REITs are a risky bunch that should trade at a discount to other REITs, their leases are the opposite of the triple-net lease industry in that their "leases" are extremely short term (overnight) in nature, meaning in a recession earnings can evaporate pretty quickly.

Valuation
The pro-forma financials in Ashford Inc's propectus are pretty messy and I'm not sure they really tell us a whole lot about what the future operating performance will be.  For instance, proforma 2013 numbers indicate an operating margin of just over 10%, extremely low for an asset manager, should be more in the 30-40% range and I would expect the company to right size costs as a standalone entity.  Let's approach valuation another way, a common valuation metric for asset management companies that I've seen is 10x pre-tax earnings, not entirely sure of the origin, but it seems reasonable to me.  Using that as a yard stick, I backed into what the market is currently pricing in as their pro-forma operating margin and an implied AUM figure below:

So it appears that the market is a little ahead of itself or expecting a lot from Ashford's hedge fund effort and their incentive fees.  While I'm passing on AINC for the time being, it's been an interesting exercise and as a result I'm going to be taking a closer look at both the ACAS (the management company will keep the NOLs) and PSEC asset management spins coming in 2015.  Are there any others to keep an eye on?

Disclosure: No Position