BRT Apartments: Another Sunbelt Multi-Family REIT with Governance Issues

I didn't mean for this to be a mini-series, but as I was looking through ARL/TCI I remembered another REIT that I looked at years ago, BRT Apartments (BRT), that fits as an addition to the "sunbelt multi-family M&A craziness" themed basket.  BRT Apartments is primarily a class B, value-add, garden style apartment portfolio in the southeast and Texas (35 properties, ~9500 units, ~$1150/month rents, loosely similar to NXRT's portfolio).  

BRT also shares some similarities to TCI but thankfully is a little simpler, it owns both apartment buildings directly and through unconsolidated joint ventures which makes the accounting a bit challenging to untangle (typical REIT investors shun complexity), and it is also family owned with the Gould family owning ~25% of the stock.  The founder, Fredric Gould is 85 and still a member of the board, his two sons hold executive positions including one that is the CEO, and a cousin is also involved as an EVP.  The governance issues here don't seem as egregious as ARL/TCI but maybe on par with BRG.  The Gould family does have a shared services agreement with their family office that provides "investment advice and long-term planning" and other services to the company (sounds like something an internal REIT shouldn't need to outsource), which has averaged about $1.4MM in each of the last several years.  BRT also uses a property manager for some of their properties that is wholly owned by the Gould family.  The Gould's also previously managed the company via an external asset manager "REIT Management" but this is now technically an internally managed REIT.

While I haven't seen any press leaks regarding BRT running a sales process, I'm just going on the assumption that every smallish sunbelt apartment REIT is receiving inbound calls from bankers and private equity shops kicking the tires, effectively all are probably evaluating strategic alternatives.  I'm going to keep this one quick (BRT has a long history, was previously a lender to multi-family pre-GFC, foreclosed on properties, became the owner, etc, but now pretty clean, just sunbelt multi-family apartments), but if you break out the two baskets:

The left side is the 8 apartment complexes they own outright with the NOI being Q3 annualized numbers and the right side is the 27 apartment complexes they own through various joint ventures and their proportional NOI and mortgage debt as disclosed in their supplement package.  The quirk I'm a bit unsure of is for the unconsolidated properties I'm using a 5.0% cap rate just for complexity/limited disclosure of these JVs (there is minimal other obvious difference between the portfolios).  BRT has been trying and occasionally been successful buying out their joint venture partners and presumably a financial buyer would need a little extra juice to go through a similar process although it's not uncommon for non-100% interest in properties to trade.  The problem/lack of disclosure is in how these JVs are structured, for example BRT might own 80% of the joint venture's equity but their minority partner might get a preferred return and these terms are only disclosed at a very high level (if anyone is familiar with the details, please let me know):  

Joint Venture Arrangements

The arrangements with our multi-family property joint venture partners are deal specific and vary from transaction to transaction. Generally, these arrangements provide for us and our joint venture partner to receive net cash flow available for distribution and/or profits in the following order of priority (in certain cases, we are entitled to these distributions on a senior or preferential basis): (i) a preferred return of 9% to 10% on each party's unreturned capital contributions, until such preferred return has been paid in full; and (ii) the return in full of each party's capital contribution. Thereafter, distributions to, and profit sharing between, joint venture partners, is determined pursuant to the applicable agreement governing the relationship between the parties. Generally, as a result of allocation/distribution provisions of the applicable joint venture operating agreement, the allocation and distribution of cash and profits to BRT is less than that implied by BRT's percentage equity interest in the venture/property.

If you gross up the JVs (BRT owns ~67% of the equity on average), that works out to about a ~$171k/unit acquisition price, versus BRG at about ~$300k/unit, although BRG's rentals are a little more premium at $1400/month.  To spot check that math, they recently bought out their joint venture partner in a Nashville, TN complex for $165k/unit.

If my math isn't wildly off (it might be), shares are still reasonably undervalued using market cap rates despite jumping last week after the BRG buyout (I'm not alone in thinking BRT Apartments could be next).  At a certain point taking advantage of the public-to-private valuation arbitrage available in these apartment REITs outweighs the benefits of keeping it public to the Gould family.  Similar to BRG, since this is really a "will they or won't they sell" bet, I'm going to play the idea through call options, this time I just went out to June '22 and bought the at-the-money $22.50 strikes hoping this is a replay.

Other thoughts:

• They have used their ATM offering this year, which isn't exactly a sign they're shareholder friendly or think their shares trade at a huge discount as I suggest, but BRG did similar things with the preferred share exchanges there.  Some of the ATM issuances were before inflation talk really heated up and we saw a lot of activity in the space, but it is still worth mentioning as a negative.
• The Gould family also runs another REIT, One Liberty Properties (OLP), that's mostly an industrial net lease, attentions and salaries could potentially be repositioned there as that sector also has covid tailwinds.  At BRG they found a creative way to keep their jobs by spinning out the SFH rentals, here they could just all move over to their already established REIT.
• I also noticed the Gould family has created a cannabis investment firm, Rainbow Realty Group, could be the seeds of a future cannabis mREIT or other lending structure that have become popular ways to invest in cannabis on U.S. regulated exchanges (e.g., I noticed the old Fifth Street Asset Management (FSAM) team popped up at AFC Gamma (AFCG)).  Maybe cash out here and reinvest in that hot theme?

Disclosure: I own BRT June $22.50 call options (and ARL, BRG calls)

American Realty Investors: TCI Multi-Family JV Portfolio for Sale

*Disclaimer: This is another closely held, illiquid micro cap*

Last week, Bluerock Residential Growth REIT (BRG) agreed to be acquired by Blackstone (excuse the small victory lap) for a healthy sub-4% cap rate on their multi-family portfolio, surprisingly Blackstone was willing to take BRG's (possibly non-arm's length) lending portfolio which I thought might be an impediment to a deal happening.  We know the multi-family sector is getting crazy (especially in sunbelt markets) when even a REIT with a poor governance structure sells out versus grifting on related party deals to the end of time.  The natural next question, what other poor governance structure multi-family stocks are out there and could something like this deal happen again?  Which brings me to Transcontinental Realty Investors (TCI) and its largest shareholder American Realty Investors (ARL).  I've add this complex to my hairy "hidden" multi-family real estate bucket alongside HMG and BBXIA.

TCI is one of the original REITs (it converted to a c-corp many years ago due to ownership concentration limitations), it goes back several decades and could be described as pioneer in poor governance situations (almost like an RMR REIT before RMR).  Back in 2001, the Wall Street Journal ran a front page story on Gene Phillips, the controlling investor in a series of real estate companies that had (and still have) cross ownership interests and related party transactions: Income Opportunity Realty Investors (IOR), Transcontinental Realty Investors (TCI) and American Realty Investors (ARL).  There's even a Bill Ackman reference in the article, his old fund Gotham Partners, went activist on TCI.  Gene Phillips died in August 2019, the trust for his 7 children are now the controlling shareholders via Realty Advisors, Inc ("RAI" - not publicly traded).

These three companies still exist, their relationship is a bit of Russian nesting doll, RAI owns 90% of ARL, ARL owns 78% of TCI (RAI owns another 7% in TCI directly) and TCI in turn owns 81% of IOR (RAI owns another 2% in IOR directly).  Each step of the way, there is an external manager, Piller Income Investment Management (wholly owned, by you guessed it, RAI), that collects a 0.75% of assets annually, 7.5% of net income and 10% of asset sale capital gains above an 8% hurdle.  None of these entities pay a dividend, they pretty much solely exist as fee revenue streams for the Phillips' heirs at this point.  The accounting is confusing because there are intra-complex loans outstanding and ARL consolidates TCI and TCI consolidates IOR, it's one big mess to untangle.

Most of the assets are at the TCI level (to get even more confusing, technically "Southern Properties Capital" or "SPC" in their filings is the wholly owned subsidiary of TCI that owns most of the assets and secures the Israeli bonds), where it gets interesting today is in 2018, TCI sold the vast majority of their multi-family portfolio (53 buildings in the sunbelt, now 51) into a JV (named Victory Abode Apartments or "VAA") entered into with Macquarie.  On 11/21, the two announced an agreement where they would sell the properties in the JV (with TCI essentially taking back/buying 7 of them) in early 2022.  The JV portfolio is held on TCI's (and ARL's) book using the equity method of accounting, there's also an odd mezzanine loan that is equally owned by the JV partners that should be treated as equity, either way, the carrying value of the portfolio is understated on the balance sheet, likely by a wide margin.  From the latest TCI 10-Q:

To mark-to-market the JV, here's the Q3 operating results:

If we annualize Q3 NOI, I get about a $69MM run-rate, at a 4% cap rate that's an asset value of $1.726B, there's $856MM mortgage, TCI owns 49% (Macquarie has 49%, and then TCI's former CEO strangely still manages the JV and has 2%), for a $426MM pre-tax, pre-fees value to TCI.  Out of that number, TCI owes Macquarie $34MM left on an earnout that the two went to arbitration over (probably a marginally net negative readout, there were 10 properties under construction included in the JV portfolio, guessing to-date these didn't stabilized as expected when the contract was struck, but the environment is different now, even marginal properties are likely performing well).  And then external manager Pillar is going to get a cut of the sale proceeds and there will be taxes to pay since TCI is a c-corp and not a REIT.  But even after all that (I'm honestly not even sure how to estimate it) there still seems to be plenty of margin of safety here given that TCI's market cap is only $337MM (using a $39 share price).  And again, TCI is buying 7 of the properties from the JV, so they're not going to get ~$400MM cash dropped in their lap, it'll be some fraction of that.

On top of the VAA JV, TCI owns real estate directly in three buckets: multi-family, commercial and development land.

Similarly annualizing the Q3 NOI ("Profit from segment" here seems analogous NOI) for the multi-family segment and putting a 4.5% cap rate on it (moving it up a touch for fun/since its not on the market) and I get about $145MM in asset value.  For the commercial side (mostly office, one retail property), using a 7% cap rate, I get about $135MM in asset value.  These feel too conservative as it is a bit below the depreciated book value (if we ex-out the land below) on the balance sheet.

Then I'm always a sucker for development assets and raw land, here TCI acquired a big plot (~2900 acres at the time) of land ("Windmill Farms") outside of Dallas back in 2011 through some convoluted restructuring:

On November 1, 2011, we acquired 100% of the membership interest in Bridgeview Plaza, LLC. On September 21, 2010, we sold our investment in EQK Bridgeview Plaza, Inc. to Warren Road Farm, Inc. (“WRF”), a related party under common control, for a sales price of $8.3 million to be paid via an assumption of debt of $6.2 million and seller-financing of $2.1 million. On October 4, 2010, WRF filed a voluntary petition seeking relief under Chapter 11 of the bankruptcy code. The approved bankruptcy plan was effective November 1, 2011, whereby TCI, for its contribution to the plan, was given 100% equity ownership in the entity. During the period of time that WRF owned the equity interest, it had also acquired 2900 acres of land known as Windmill Farms land located in Kaufman, TX, previously held by ARL, for a sales price of $64.5 million. ARL provided $33.8 million in seller-financing with a five-year note receivable. The note accrues interest at 6.0% and is payable at maturity on September 21, 2015. WRF assumed the existing mortgage of $30.7 million, secured by the property.

The land is located in Kaufman County, TX, which is southeast of Dallas and not the most desirable part of the metroplex, but as Dallas continues to heat up, the sprawl has moved towards TCI's land.  By my math, they're down to 1,420 acres currently, here are the recent sales prices from the last few years:

During the nine months ended September 30, 2021, we sold a total of 134.7 acres of land from our holdings in Windmill Farms for $19.0 million, in aggregate, resulting in gains on sale of $9.2 million.

During the year ended December 31, 2020, we sold a total of 58.8 acres of land from our holdings in Windmill Farms for a total of $12.9 million, resulting in a total gain on sale of $11.1 million.

I don't want to get all HHC/JOE math on people, but the carrying value for all their development land is $42MM, and the average price they've transacted with homebuilders the last two years is $165k/acre, now we don't know how much development capex or time it would take the sell the remaining 1,420 acres, but the value is certainly more than $42MM.

And then there's the 81% stake in IOR, IOR's loan book is full of related party transactions (similar to BRG's loan book) used to fund TCI's apartments and development activity, it was probably intended to be a true mortgage REIT, but now is just a nano cap that is unlevered and houses most of the loan book on TCI/ARL's balance sheet.  Again, no dividend, only exists to generate fees.  But the book value is $107MM, so 81% of that is $87MM (IOR trades for less than half book value, could be interesting on its own if the complex does fold up?).

On the right side of the balance sheet there's $185MM of Israeli bonds (they do report on IFRS there, others have translated the filings to come up with similar findings) and $178MM in direct mortgage debt, for a total of $363MM in long term debt at the TCI level.  There are other assets, cash, loans that aren't in IOR, related party deals, but they're hard to untangle and I'd probably get it wrong, so very high level swag:

• $350MM for the VAA JV after fees and taxes (some of this is the retained value of the 7 properties)
• $280MM in owned properties
• $150MM in land
• $87MM in IOR
• ($363MM) of long term debt

Or about $500MM to TCI, or ~$60/share (probably conservative here, there a lot of unknowns), it trades for $39/share with a clear catalyst the JV sale in the first half of 2022.  

Another way to play TCI -- I've reluctantly chose this path -- is via the even more illiquid ARL.  ARL's market capitalization is $187MM, the only significant asset they own is an 80% stake in TCI, so buying via ARL you're effectively buying TCI equity for $230MM (I could be wrong here, there are intracompany loans, hard to tell what's what, but I think they net out (minus some minority interest leakage)?).  Now there are more risks to ARL, you're one step from TCI and are counting on the discount being closed by the whole complex being collapsed (ARL has no reason to exist after all).  

That is unlikely to happen, I'm probably too bulled up on sunbelt apartments, but with the family patriarch gone, the kids don't appear to be closely involved here, craziness in the multi-family sector, maybe the JV sale is the catalyst to just collapse the whole thing or use the cash to take out minority investors via a go-private offer.  The grift is egregious here, but it's really only on the minority shareholders and that's a relatively small piece of the pie (90% of ARL * 78% of TCI = 70% + 7% directly owned = 77% look through ownership of the multi-family portfolio), selling out at the top is probably worth more than stealing from ~23% of outside shareholders throughout the complex.  If a sale or going-private deal doesn't happen, its probably just an okay investment, it'll still trade a huge discount, but should bump up a touch, versus owning TCI probably reacts better in the base case scenario that the JV sells for going markets rates and TCI just reinvests the proceeds to keep the scam going.

Other thoughts:

• TCI did receive a $44/share buyout offer, but the proposal hasn't gone anywhere and was probably just for publicity anyway.
• TCI's book value is ~$41/share, given how mis-marked the VAA JV is on the balance sheet, and that GAAP accounting often understates real estate value (historical cost minus depreciation), its rare that a multi-family company would trade at a discount.  Both highlights the undervaluation and the markets skeptical view that it ever gets resolved.  Similarly, ARL book value is $21/price versus a $11.50/share price.
• Buying back the 7 properties is kind of a "bad fact" to a full sale/liquidation thesis, but with the cash, might end up getting a low-ball going private offer that still results in a satisfactory result.  If that's the case, probably best to own TCI directly (talking myself out of ARL right now).  My best guess is these are some of original development properties that might not be fully stabilized and won't fetch full value in a competitive auction.
• Macquarie is the adult in the room, will want to maximize value and reduces any related party risks to the actual sale of the JV, but the management grift factor remains elsewhere in the complex.
• Brad Phillips, Gene's son, is the president of a life insurance firm.  There are 58 people according to LinkedIn that work at Pillar Income Asset Management, it appears they don't manage considerable assets outside of ARL/TCI/IOR.  One article I found lists Gene Phillips' estate at $3.5B, so there might be other assets outside of this mess, presumably they could take out minority shareholders and run this as a family office, not that they will of course.

Disclosure: I own shares of ARL (might add TCI directly too), (and still holding HMG, BBXIA, BRG calls)

Vector Group: Douglas Elliman Spin (Watchlist)

*Just a watchlist item for now, think it is fairly valued unless you have a divergent view on DOUG*

Last month, Vector Group (VGR) announced the long speculated spinoff of its real estate brokerage business, Douglas Elliman (DOUG), to shareholders before year end (quick!).  The distribution date is now set for 12/29 (tomorrow).  This situation is sort of a "classic" spinoff where the two businesses operate in completely separate industries and should have completely separate shareholder bases.  The spinoff is a brokerage that supports high-end real estate agents and the parent is basically the complete opposite, a discount cigarette manufacturer, can't get much different.  These are usually more interesting to me than an industrial splitting into two or three, here no one is owning pre-split VGR because they want exposure to the high-end real estate sales cycle, it's a tobacco business and thus untouchable to many investors for ESG or other reasons.  Spinning off DOUG opens the spin up to a much wider shareholder base and it should logically trade at a valuation above where the combined VGR does today.

Vector Group (VGR) (RemainCo)

The remaining business will be primarily a tobacco company.  Vector has approximately 4% market share in the U.S. cigarette market, well behind the larger premium branded players like Altria (MO) or British American Tobacco (BTI).  Vector's main brands include Eagle 20's and Pyramid, I'm not a smoker, but these don't seem like household type brands.  I did do a peek behind the register at my local Walgreens and found them on the bottom, near the floor, not the best product placement.  Traditional cigarettes are obviously in long term decline (although revenue continues to increase thanks to price increases), they're gross and kill their customers, while others have been moving into smokeless nicotine alternatives -- Vector briefly flirted with e-cigs before closing the unit -- they instead just focus on their discount and deep-discount niche (typically priced 15%-35% below brand names).

The tobacco segment did $360MM of LTM EBITDA, there's minimal capex, but obviously these businesses don't trade at high multiples and cigarettes has been a bit of a covid beneficiary (stimulus payments, more time spent at home, about the last place you're allowed to smoke, etc) and actually saw growth in volumes for the first time in a couple decades.  I'm going to give the core tobacco business a 7x multiple on $340MM (some of the covid bump reverts and adjusting for corporate overhead) and get an EV of $2.4B for this part of the business.

Alongside the tobacco business, the parent is going to retain Vector Group's grab bag of investments in various real estate investments.  I won't pretend to know the entire back history here, but it appears the excess cash flow generated from the tobacco business (Vector has a regulatory cost advantage if their tobacco market share remains small, so reinvestment in tobacco doesn't make a lot of sense) was redirected to real estate projects and Douglas Elliman.  This kind of resembles what I picture the HMG private investments to look like, a bunch of random minority interests in real estate deals (some as little as 1% interests):

It's not going to show up well here, but it is page 61 of the latest 10-Q.  The table is a bit of a mess and likely impossible for an individual like me to go through and attempt to value each of these interests.  Many of these properties are luxury condos that have some appearances of synergies with the Douglas Elliman business, which does a lot of new development sales.  The carrying value of these assets are $83.7MM total, but due to equity method accounting and other GAAP rules, it's likely this value is understated but just impossible to say by how much without significantly more time for due diligence.  Additionally the remainco will have approximately $375MM (net of their tobacco MSA expense they usually pay in Q4) in cash and marketable securities/hedge fund investments.  Some of these investments strike me as odd as the tobacco operations do have $1.4B in debt, some of which is at a 10.5% interest rate, I doubt their investment grade securities portfolio or hedge fund investments are meeting that hurdle on a risk adjusted basis.

But valuing the cash, investments, real estate at book and the tobacco business at 7x, I get about a $9.40/share value for the post-spin shares.  I would be more interested in this business if the capital allocation was cleaner and it just either bought back stock regularly or paid out in dividends in the free cash flow. 

Douglas Elliman (DOUG) (SpinCo)

The spinoff is a high-end real estate brokerage firm that is positioning itself similar to Compass (COMP), where they're really in the business of servicing the top brokers in expensive coastal type markets in New York, LA or Miami versus say more of a franchise company like RE/Max (RMAX) or Realogy (RLGY) that target the mass market.  It's the brand you see on real estate broker reality shows, for example, Million Dollar Listing LA's Josh Altman and Josh Flagg are affiliated with Douglas Elliman.  They of course also do more upper-mass market type transactions, but the average house they sell is approximately $1.6MM.  DOUG is way overweight NYC with approximately 50% of their business coming from the New York metro area, but overall they are the 6th largest brokerage in the country.

To compete for these high end brokers, DOUG has invested in an agent portal offering, "PropTech" investments, and in ancillary services like mortgage origination, title insurance and escrow services.  All in an effort to attract the best talent, they even call their acquisitions "aqui-hires" because they're really paying for the people when they enter a new market.  Having their own direct equity currency versus being grouped with a tobacco company makes perfect sense if the plan is to use their equity to expand their footprint beyond the few gateway markets they service today.

I have a little trouble about how to think of this business, their revenue line is the gross commission received in the real estate sale, but about 75% of that goes to the agent off the top.  The rest is used to pay for marketing, operations, G&A overhead etc, so the bottom line looks quite skinny against the reported GAAP revenue number.  Covid obviously briefly devastated this business, being heavily focused on New York and subsequent shutdowns, Douglas Elliman did a lot of cost cutting and layoffs (25% of corporate staff, not renewing fancy offices, etc) in mid-2020 as business came to a standstill.  Like other industries, there's some debate on how much of the cost cutting will be permanent, but signs coming out of the lockdowns are much of their cost cutting initiatives are permanent and since this business has a lot of operating leverage, business has boomed.

From their investor deck:

And then the corresponding boom in EBITDA:

This is a good but super cyclical business, there's a lot of operating leverage plus there's a lot of net revenue leverage with the size and growth of the luxury high end market.  DOUG is almost a play on the continued wealth gap in America.  I could be really wrong about the multiple, COMP is a hotly debated company, but VGR has hinted at spinning off DOUG for 5-6 years, this is not a garbage barge spin and they expect it to trade higher than the combined entity.  They've expanded to markets like Texas and Colorado, it's difficult to parse out what "normalized" EBITDA would look like for this business and how much is covid related (they do actually hint that they've achieved these numbers "despite COVID-19 related headwinds", guessing they mean a lack of inventory and they expect this trajectory to continue).

For every two shares of VGR shareholders own, they'll receive one share of DOUG.  DOUG will also be spun debt free with $200MM in cash, they do guide to an additional $16.5MM in corporate overhead due to the spin (I'm probably double counting some corporate overhead on the VGR side below as DOUG is paying VGR for the office leases and other items).  Throwing a 10x EBITDA multiple on DOUG and I get a $14.25 share price.

Add it all up, and I get roughly today's share price, but still one to watch after the spin, especially if DOUG ends up getting removed from small cap indices.  As always, correct me if I'm missing something big here, slow holiday work week so decided to write it up anyway, I was hoping to like this one more.

Other thoughts:

• Phil Frost is a 9.5% holder of VGR, he has a colorful history including being caught up in a pump and dump scheme.  Overall management here seems a bit grifty and the whole idea of a tobacco company originally buying DOUG seems like a vanity acquisition, it is probably a lot of fun to be the CEO of DOUG.
• I tend to like quick spins, usually they're smaller companies and it shows they've been run separately and really only connected through corporate G&A, if a spinoff takes more than a year, usually means there's a lot of parts to untangle, more likely the company has a tough go of it early on as a newly public company.

Disclosure: No Position

Altisource Asset Management: Preferred Overhang, Cash Shell w/ Optionality

Many readers will know this situation, Altisource Asset Management (AAMC) is a cash shell with approximately $80MM in the bank after their only asset management client, Front Yard Residential (RESI), terminated their external management agreement with AAMC resulting in RESI being internalized (AAMC was a 2012 spin, was trendy at the time to spin the management company).  Front Yard later sold itself to private equity (Ares and Pretium) which likely will turn out to be a great deal (even after they hiked the offer) for the buyers given how single family rentals have traded since.  Friend of the blog, Andrew Walker did an excellent podcast (and even answered one of my questions on it) with Thomas Braziel and Jeff Moore pitching AAMC.  They go into some of the background, particularly on the controversial Bill Erbey, who was formerly an executive (back in the early-to-mid 2010s, Erbey ran Ocwen and a few satellite entities like AAMC), but now is *just* a 39% shareholder in AAMC after legal trouble forced him out of the day-to-day operations.

Long story short, Altisource has a large preferred overhang (originally $250MM, currently $150MM after two exchanges), the stock previously traded north of $1000/share (now for $17.90) and issued a zero coupon convertible preferred stock with a strike price of $1250.  The cash from the convertible preferred was used to buyback shares, presumably to boost the shares above the strike price making everyone happy, but instead the stock collapsed.  Now that piece of paper is hopelessly out of the money, it is basically a zero coupon bond with a mandatory redemption date of 3/15/44.  However starting in March 2020, every five years the preferred holders can request a full redemption:

(b)    Each holder, at its option, shall have the right, in its sole discretion, to require the Corporation to redeem all of its outstanding Series A Preferred Shares by providing written notice to the Corporation within fifteen (15) Business Days (but not more than thirty (30) Business Days) prior to a Redemption Date of its intent to cause the Corporation to redeem such holder’s Series A Preferred Shares on such Redemption Date (each, a “Holder Redemption Notice”) which will specify (i) the name of the holder delivering such Holder Redemption Notice and (ii) that such holder is exercising its option, pursuant to this Section 5, to require the Corporation to redeem shares of Series A Preferred Shares held by such holder. The Corporation shall, within fifteen (15) Business Days of receipt of such Holder Redemption Notice, deliver to the holder exercising its rights to require redemption of the Series A Preferred Shares a notice specifying the date set for such redemption, which date shall be no more than thirty (30) Business Days after the Holder Redemption Notice (the "Holder Redemption Date"). The Corporation shall redeem for cash on the Holder Redemption Date, out of funds legally available therefor, all, but not less than all, of the outstanding Series A Preferred Shares held by such holder at an amount equal to the Redemption Price.

The larger holders did indeed request redemption last year.  But the trick is AAMC has to redeem the entire class at once, and obviously they can't redeem the $150MM outstanding with only $80MM in net cash.  The preferred stock is closely held, two holders (Putnam and Wellington) have settled with AAMC and exchanged for either a combination of cash and stock in the case of Putnam or just cash in the case of Wellington.  Both worked out to approximately 11-12 cents on the dollar.   The remaining significant holdout is Luxor Capital which is pursuing litigation against AAMC.

I have never subscribed to the "preferred stock has no teeth" thesis, here is where my views differ (again, I'm often totally wrong):

• Luxor is not anchored in any way to the previous two settlements, they're the largest holder (basically the only remaining holder) of the preferred stock and still have leverage.  I'm a structured finance guy, they're almost the "controlling class" in this situation, without them the overhang isn't resolved.  Additionally, Putnam included a "most favored nation" clause in their settlement which effectively hitches their settlement to Luxor, it gets Putnam out of the lawsuit but also allows them to retain the optionality of a better deal.
• Altisource won't risk consummating a new business combination/merger before the preferred stock overhang is resolved.  If the deal is successful, then AAMC could potentially be on the hook for the full $150MM down the road or at a minimum increases the recovery rate for Luxor.  I don't see anything happening until Luxor settles, maybe there's a settlement and merger simultaneously but it feels highly unlikely that the preferred can just sit out there until 2044 (for either side).  So this is a game of chicken until then, and those situations can last longer than people want to believe (I would have thought RHE would have settled by now).

But the price has fallen considerably in the last several weeks to $17.90 today, at this price the thesis seems more interesting (basically back to where it was before Wellington settled) and allows some margin of safety in the circumstance that Luxor strikes a significantly better deal than either Putnam or Wellington did.

Here's the current situation, obviously the capital structure is upside down at full face for the preferred, I'm discounting the net cash for two quarters of cash burn, dealers choice there.

How I'm thinking about a post-settlement proforma: I'm assuming that the Putnam settlement is the best case.  Putnam held $81.8MM of the preferred stock and received 288,283 shares of stock and $2.863MM in cash (split in two payments), if we applied that ratio to the remaining $150MM outstanding, I get about a $25 NAV.

But if Luxor was going to settle for the Putnam deal, they would have already, so applying a multiple to that, let's say they negotiate a 25% or 50% better deal than Putnam, I get an NAV of $23.28 and $21.50 respectively.  Against a $17.90 stock, that seems like a reasonable discount, if you did a goal seek on the multiplier to get to the current price, Luxor would need to strike a deal more than 100% better than Putnam (also includes the incremental benefit to Putnam for MFN clause) to get to the current share price.

I'm not going to speculate on a deal target, the podcast interview I referenced does a bit of that if you're interested, but AAMC included in the below in their Q3 earnings release:

Mr. Thomas K. McCarthy, Interim Chief Executive Officer, stated, “The Company’s attention and focus continues to be the evaluation and pursuit of certain business opportunities and acquisition targets in which to focus the Company’s resources and enhance shareholder value. The Company has liquidated its equity holdings and is now in an all-cash position in preparation of an acquisition event.

During the third quarter, the Company also engaged the services of both an investment bank, Cowen and Company, LLC, and the law firm, Norton Rose Fulbright, LLP, to assist us in identifying and reviewing potential acquisition and merger opportunities. While no final decision has been made, the Company is in discussions with several potential acquisition or merger targets including cryptocurrency and brokerage related businesses”.

The company is probably mid-process, I'm guessing that a settlement with Luxor is announced at the same time (if they take shares, they could participate in the upside, removing the litigation overhang will likely cause the stock to bounce significantly), plus there are some "meme able" buzzwords in there and a relatively low float, I agree that something crazy could happen with this one and at today's price you're not paying much, if anything, for that optionality.  But there are hundreds of SPACs also competing for similar buzzy deals, so who knows, could be challenging to get a deal done and there could be a frustratingly long stretch with no news.

Disclosure: I own shares of AAMC 

Sonida Senior Living: Out of Court Restructuring, fka Capital Senior Living

Sonida Senior Living (SNDA, fka Capital Senior Living under the old symbol CSU) recently completed an out of court restructuring led by Conversant Capital, the same investor that has been instrumental in institutionalizing and providing growth capital to INDUS Realty Trust (INDT).  While clearly different, the industrial/logistics asset class has covid tailwinds versus senior housing having covid headwinds, the results could rhyme with each other longer term as this micro cap "grows up" (to steal a tweet from "Sterling Capital" @jay_21_, also h/t for the idea). Sonida is now positioned to use their reset balance sheet to take advantage of a fragmented senior housing market with plenty of distress (looking over at our friend RHE), but also with long anticipated demographic tailwinds finally being realized with an increasingly large population aging into senior housing.

Below is the standard investor relations overview slide.  Unlike some others in senior housing, SNDA is not a REIT (more similar to BKD), but owns and operates the vast majority of their facilities as they exited locations the company formerly leased from others (VTR, WELL, PEAK etc) in recent years.  There's embedded real estate value at SNDA as a result, which may someday lend itself to some kind of REIT transaction.  They also have a small management business that resembles Five Star's (FVE) business model (got there in a similar way too when SNDA restructured their leased properties) that helps offsets some G&A in the meantime.

The restructuring agreement took a few twists and turns, including heavy opposition from 12+% shareholder Ortelius Advisors, but was eventually approved by shareholders in October and closed earlier in November.

A total of $154.8MM (net $140.8MM) was raised through a combination of:

• $41.25MM in convertible preferred stock (11%, conversion price of $40) to Conversant plus an additional $25MM accordion to the convertible preferred stock if needed for growth capital 
• $41.25MM in common stock at $25/share to Conversant, plus warrants to purchased an additional 1 million shares at $40/share
• $72.3MM through a rights offering at $30/share to all company shareholders
• Conversant previously provided a $16MM rescue bridge loan to the company, it was repaid in full upon closing of the transaction on 11/3/21.

Most of the capital is going to be used to stabilize the company's balance sheet and take care of some deferred maintenance capex the company likely punted on the last two years.  The capital basically allows the company to recover and get back to some kind of normalized operating environment.  Senior housing has had the unfortunate position of getting hit by covid from both the revenue and expense side.  It's not fun to mention but obviously covid caused a lot of deaths in this age group and likely prevented a lot of move ins as family members stayed home and turned into caregivers to avoid subjecting love ones to senior housing during a pandemic.  On the expense side, first they had PPE expense and now a tight labor market which is squeezing their margins.

But attempting to look through to what their results could look like in a year or two as the world normalizes, the key numbers to run a scenario analysis are the occupancy and NOI margin (I'm going back to YE 2017, no good reason just seemed "normal", for their owned properties they did 88% and 38% respectively):

To be clear, they're a ways away from normal, as of their last earnings report, occupancy was 82.3% and NOI margin was 21%.

For the cap rate, it's a bit tricky too, senior living is similar to hotels where if you're the owner operator it's less of a real estate business and more of a service business.  But Ventas (VTR) recently purchased Fortress controlled New Senior Investment Group (SNR) for $2.3B:

"The transaction valuation is expected to represent approximately a 6% capitalization rate on expected New Senior Net Operating Income ("NOI").. the acquisition price implies a 20% to 30% discount to estimated replacement cost on a per unit basis.. the transaction price represents a multiple of <12 times estimated 2022 New Senior normalized FFO per share including full synergies."  

It's not an apples-to-apples comparable, New Senior didn't operate their properties, just leased them out which is arguably less risky (although a lot of senior housing REITs have had to take back properties) but at least allowed them to be a REIT and lower their cost of capital.

The proforma debt and share count is a little messy, I've probably made some errors here, so those who know better, please feel free to correct me.

That compares favorably to today's share price of ~$32 per share, but that's an asset/takeout value (doesn't include corporate overhead, etc.) and assumes a full recovery.  But also doesn't include any additional growth or deal making which will likely come in the future, based on who they've brought in, the re-branding, it all signals that this is going to be more of a growth platform (similar to the GRIF to INDT rebrand).  

On sort of a going concern basis, using normalized numbers, including the convert but excluding the effects of the warrants, I have it trading at 12.5x normalized EBITDA (below where other senior housing companies trade, but to be fair, they'd trade lower on a normalized number too).  Not screaming cheap on an absolute standalone basis, they probably need additional scale to create some operating leverage on the G&A and corporate expenses.

Other thoughts:

• I don't have the stats to back it up at my finger tips, but the dynamics in senior housing appear to be similar to those in single family residential.  There was significant overbuilding of senior housing in the middle of the last decade, then it dropped off a cliff, now we're finally seeing the long promised demographic wave moving into the 80+ cohort which could cause supply to tighten and rent/occupancy to rise.
• I like the new board of directors.  The new Chairman is Dave Johnson, he was previously the President of Wyndham Hotels (WH) and is a board member of Hilton Grand Vacations (HGV), two companies I've followed/respected for several years.  Then to repeat the tie in with INDT, Conversant is bringing in Ben Harris as a board member, formerly the president of Gramercy Properties Trust (fka GPT) which was a blog favorite, most of the other key members of that team are at INDT now.
• While not as great of an inflation hedge as multi-family due to the greater percentage of variable/labor costs in senior housing, inflation should be able to be mostly passed onto to the residents.  SNDA disclosed in a recent call that they were increasing rents by 5+% next year, VTR is targeting 8% in their owned properties, etc.
• Sonida has a fairly high concentration in Texas, Wisconsin, Indiana and Ohio.  Their facilities tend to be smallish and on the older side, about an average age of 23+ years.
• The company recently announced they'd be managing an additional 3 properties for Ventas starting 12/1, while not material yet, perhaps the managed segment could be a growth business for Sonida.  It's a fee business, not exposed to lease expense or capex of an operator, etc.
• The company is going to restart giving guidance for 2022, presumably with Q1 earnings, which could give some needed visibility to investors as I fully admit my back of the envelope math is mostly a guess at this point.

Disclosure: I own shares of SNDA (plus INDT and RHE-A still too)

HMG/Courtland Properties: Microcap REIT Liquidation

*Disclaimer: Please note that is this a $18MM market cap that is closely held and illiquid*

HMG/Courtland Properties (HMG) is a tiny REIT that recently announced intentions to hold a vote early next year to approve a plan of dissolution and liquidate.  HMG was founded in 1974 by Maurice Wiener, he is 80 and is still the CEO of the company (technically this is an externally managed REIT, but there is no incentive fee), he controls 56% of the shares through various entities leaving little doubt the liquidation proposal will be adopted.  

The company's assets are a bit of mess (this liquidation will probably take several years), but the largest asset is a 25% equity ownership in a newly constructed Class A multi-family apartment building ("Murano at Three Oaks") in Fort Myers, FL.  Construction began in 2019, the building was completed in March and is already 97% leased as of the recently released 9/30 10-Q.  With inflation running hot and migration to the sun belt, cap rates on multi-family assets like this one are being quoted below 4%.  This is a hidden play on the craziness in multi-family M&A.  

Disclosure on the property is limited.  But checking the building's listing on apartments.com, it appears the going rate for their units is around $25 annually per square foot, there are 318 units and 312,000 square feet of rentable space.  Let's round down a bit for some vacancy to $7.5MM top line revenue, again back of the envelope, let's use 40% of gross rent goes to some combination of property management, operating expenses and taxes (I spot checked a few multi-family REITs for this, could be off!), that gets you an NOI of $4.5MM on the property.  

I'm sure I'll get the comment that this asset would go for less than a 4 cap but let's use that for now too, since it just started leasing this year, guessing there's not a lot of rents that need be reset to market as leases rollover like other properties.  There's a $39.5MM construction loan on the property, so the net value to the equity under my math is ~$73MM with HMG's share of that being $18.25MM, or roughly the market cap of the company.  Their equity investment in the apartment joint venture is held on the balance sheet at $3.3MM (HMG put in $3.6MM into the project, but due to equity method of accounting, HMG recognizes the proportional losses of the project has experienced since it has been in lease up mode).  Again, sounds a bit crazy, the asset was built for $54.1MM and now seemingly worth double that or more.  Given the debt here is a construction loan and the asset is freshly stabilized, even if the equity group doesn't sell it outright, they'll likely refinance and pull a decent amount of cash out that could be used for an initial liquidation dividend.

The rest of the REIT sort of looks like someone's personal portfolio/family office, in this case the CEO's:

• The external advisor's "Executive Offices" at 1870 South Bayshore Dr in Coconut Grove, FL.  This appears to be a single-family home (unclear if the CEO uses it as his primary residence) that has a Zestimate of $2.5MM, it has a tax assessment of $1.5MM and a book value of $590k (it was purchased in the 90s).  There's no debt on the property, let's call it $2MM net to HMG or roughly another $2/share in value.
• 28% interest in a 260 River Street in Montpelier, VT, carrying value of $870k.  Tricky to tell what this really is but they had some environmental abatement issues that are seemingly behind them, a new tenant took possession of the property in March.
• About $4MM in net cash (after subtracting out ~$800k of current liabilities)
• $2.8MM of marketable securities, much of which is equities and preferred stock in undisclosed large cap REITs

Then it gets a little strange (if it hasn't already), there's $4.85MM (as of 9/30) in carrying value in 46 individual private investments, it appears like most of these are real estate related (including some multi-family which could have embedded gains) but also includes non-real estate related stuff like technology and there's an energy investment hidden in here somewhere too.  Below is the breakout from the last 10-K, the carrying values have moved around a bit but gives you a sense of the asset classes.  

These investments are carried the lower of cost or fair value, there could be some diamonds in the rough, a few excerpts from recent monetization events: 

"During the nine months ended September 30, 2021, we received cash distributions from other investments of approximately $1.03 million. This included distributions of approximately $584,000 from our investment in a multi-family residential property located in Orlando, Florida which was sold during this quarter. We recognized a gain of $315,000 from this investment." 

And this one: 

In August 2021, one of our other investments in a private bank located in Palm Beach, Florida merged with a publicly traded bank, and we exchanged our original shares for shares in the publicly traded bank. Accordingly, we have reclassified this investment as marketable securities, and as of September 30, 2021 this investment with historical cost basis of $35,000 has an unrealized gain of approximately $128,000.

But also this one:

The other OTTI adjustment in 2020 was for $175,000 for an investment in a $2 billion global fund which invests in oil exploration and production which we committed $500,000 (plus recallable distributions) in September 2015. To date we have funded $658,000 and have received $206,000 in distributions from this investment. The write down was based on net asset value reported by the sponsor and takes into consideration the current disruptions in the oil markets because of the economic fall out of the pandemic.

Even stranger there are some ~$1.5MM in loans they've made, apparently mostly all to the same person.

On the minus side of the ledger, there's about a $1MM in annual expenses between the management fee and G&A, we should probably capitalize that for at least 4 years given it's going to take time to unwind all the mess here and I get approximately ~$30/share in value and it trades for about ~$17.25/share today.  

The key with any liquidation is the timing of the cash flows.  Here it could be a reasonably attractive IRR since the largest asset just stabilized and it would make sense to either sell or refinance cash out of it in the near term.  Once most of your basis is out of the stock, it's easier to be patient on later monetization events.

Disclosure: I own shares of HMG

Advanced Emissions Solutions: Another Informal Liquidation

We're at the end of earnings season for small caps, this could be stale in under a week (ADES reports 11/10), Advanced Emissions Solutions (ADES) is a $130MM market cap with no debt and by year-end should have ~$90MM in net cash as one of their two business segments is running off due to the expiration of a tax credit.  The company announced strategic alternatives in May, likely intending to sell the remaining business segment and effectively liquidate the company.  Similar to other informal liquidation ideas lately (LAUR, PFSW, RVI, JCS, BSIG, etc), the downside is protected by the cash generated from monetizing one business segment that could be returned to shareholders either by a tender offer or a special dividend, with upside coming from an M&A event for the remaining segment.

This is an unoriginal idea, it appeared in the comment section of my Laureate Education post (might have appeared earlier but I can't find it) and other investors have shared their views with me given the similarity to others I've written up, there is also an excellent VIC long thesis on the situation.  If you've read it, you can probably stop here.

In 2011, the U.S. government implemented a 10-year tax incentive program (IRS Section 45 Tax Credit) to motivate electric utilities to use cleaner burning coal and reduce emissions.  That tax credit is expiring at the end of 2021.  Within ADES's refined coal segment, they own a 42.5% interest in Tinuum Group, which is basically a royalty business on the tax credits power plants receive utilizing their services.  In their Q2 press release, ADES is projecting $30-$40MM after-tax to be distributed to ADES from this runoff segment by year end.  Add that to the $57.3MM of cash on the balance sheet as of 6/30, and the cash balance should be roughly $90MM.  There are 18.85 million shares outstanding, that's $4.75/share in net cash on a ~$7.00 stock.

The remaining segment is an activated carbon business, Advanced Purification Technologies ("APT").  Out of their Red River Plant in Louisiana, APT produces chemical products primarily used to purify coal fired power plants (reduces mercury emissions) but they've also made efforts to diversify into other end markets like industrials and water treatment plants that aren't in secular decline.  APT was acquired by ADES in late 2018 for $75MM from Energy Capital Partners who had originally built the Red River plant for $380+MM (*correction, ADES originally built it, see first comment*).  Coal usage has declined faster than was underwritten a decade ago when the plant was built; the original greenfield investment wasn't money well spent.  Although, with natural gas prices moving up significantly this year, maybe the coal-to-gas fired plant conversion theme will slow?  As part of the acquisition, ADES also acquired the on-site lignite coal mine (Five Forks) that is used as an input to produce activated carbon, interestingly the mine operations are subcontracted out to old friend of the blog NACCO Industries (NC).

The APT business continued to struggle after ADES acquired it, covid didn't help either, but back in September 2020, ADES entered into a 15 year supply agreement with competitor Cabot (CBT) to supply activated carbon in North America that results in two important things: 1) diversifies the APT business away from coal into other end markets (also provides some revenue certainty to a buyer); 2) rationalized the competitive market by facilitating Cabot's exit from the industry.  Earlier this year, they entered into a second supply agreement with Cabot to supply international markets for 5 years.  On the negative side, Cabot had ADES take ownership of their Marshall Mine (on-site lignite mine of Cabot's plant) and immediately shutter it, reclamations efforts have begun (again, being performed by NACCO), but importantly for Cabot, the asset retirement obligation moved from its balance sheet to ADES.  The remaining ARO is about $12MM to ADES (there is a cost sharing agreement between ADES and CBT), 70% of the work/cost is to be completed in the first two years, but it could have a long tail and make a sale of APT more challenging.

Currently the APT segment is roughly breakeven, but appears to be inflecting, per the press release describing the Cabot supply agreement inked in Q4 2020:

We expect our production to ramp up incrementally during a 4-5 quarter transition period, which when complete is expected to yield the following net impacts to our current operations:

•Incremental annual revenue growth of 30% - 40%;

•Incremental annual EBITDA growth of $10 million to $15 million; and

•Diversified end markets will reduce our power generation exposure to less than 50% of product portfolio.

Presumably ADES should start to see some improvements in Q3 results given that 4-5 quarter timing (the backdrop for their remaining coal exposure seems positive as well) and hopefully hear some hints the Red River plant's utilization rate is ramping, this is a high fixed cost business so the operating leverage can be pretty huge.  ADES bought the business for 4.2x EBITDA back in 2018, implying $17-18MM in EBITDA, it doesn't seem unreasonable that the post-covid run rate (including the CBT supply agreement) is above that number.  Conservatively assuming that the APT segment is worth what ADES paid in 2018, $75MM, netting out the $12MM in ARO, gives a $63MM "remainco" valuation or $3.35/share.  Add that to the net cash and its at least an $8.10/share stock, that's probably conservative on both sides, coal is surprisingly hot (meaning the remaining royalty could be closer to $40MM) and APT should be worth more than $75MM post CBT deal.  But I'm not an engineer, only have a loose idea of what activated carbon is based on YouTube, this is clearly more a situation I like (rhymes with others that have done well with recently) more than the business itself.

Other thoughts/notes:

• ADES has $93.8MM of federal NOLs, in order to protect against a change of ownership that would eliminate the NOL, the company put in a plan in place effectively prohibiting anyone from acquiring more than 4.99% stake in the company.  Given the small market cap, the plan limits the potential pool of investors.  Also leads itself to a liquidation mindset as the NOL should provide a tax shield.
• In March, ADES felt confident enough in the trajectory of the business to institute a price increase.
• The Red River plant is a low-cost (reportedly the lowest-cost AC producer), underutilized asset, that thesis alone could appeal to PE buyers.

Disclosure: I own shares of ADES