|Shares Out. (in M):||29||P/E||0.0x||0.0x|
|Market Cap (in $M):||355||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
Ares Commercial Real Estate Corp (ACRE) trades at ~87% of book value, and pays an ~8.0% dividend yield. We believe the company has the ability to meaningfully increase dividend. Interestingly, We believe that a substantial catalyst has ALREADY taken place just this morning, but have not yet been recognized by the market. We believe that there could be nearly ~60% upside to ACRE stock over the next 12 months.
ACRE Overview/Quick History
ACRE is a commercial-real estate originator, structured as a REIT. The business model is fairly straightforward. ACRE makes mortgage loans on commercial properties (primarily first lien loans) and uses wholesale financing (bank lines/capital markets) to obtain leverage. ACRE earns the spread between the interest it receives on the loans it makes, less the interest it pays on its financing. The vast majority of both ACRE’s assets and liabilities are floating rate.
ACRE commenced operations in December of 2011, and is externally managed by a subsidiary of Ares management. ACRE completed its IPO in April 2012 at a price of $18.50. The share price has declined dramatically since the IPO. Importantly, in June of this year, ACRE completed a large equity raise, the dilution from which we believe is the main culprit of the share price decline. The offering was announced on June 17, when the share price was $16.50. The offering was priced on June 21, at a price of $13.50. Since ACRE was a small company, lesser known company, the deal had to be marketed for a few days. The timing of the offering proved to be unfortunate, as the S&P sold off ~5% during this time, as the timing of the announced raise coincided with the “taper tantrum” experienced by the equity markets. As ACRE was trading at a significant discount to book value by the time the offering had priced, the equity raise significantly diluted existing equity holders. Book value per share declined from $17.65 per share before the raise to $14.48 in the quarter after the raise.
In the time following the equity raise, ACRE’s share price has languished, drifting down from the $13.50 offering price to ~$12.50 today. We do not have a logical fundamental explanation for this poor performance. One could postulate that ACRE has traded down with REITs in general as interest rates have backed up. However, as we mentioned above, ACRE’s assets and its liabilities are both floating rate, meaning that if interest rates increase, ACRE will make more money, so rates going up should actually be POSITIVE for ACRE.
Regardless of the reason for why the stock is where it is, at today’s price, with ACRE trading at ~87% of book value and paying a dividend of ~8.0%, we believe that this is an excellent entry point into ACRE’s stock. We explain our rationale below.
Our thesis on ACRE is straightforward: With the recent capital raise, ACRE has increased its scale, and is poised to dramatically increase profitability and potentially meaningfully raise the dividend. Additionally, we believe the securitization, announced THIS MORNING, is a significant catalyst that has yet to be recognized by the market.
We believe that ACRE can grow its investments to ~$1.35bn from ~$765mm in MRQ, or a growth of over 75%, without having to issue more equity. We believe that on this asset base, ACRE has the potential to generate EPS of ~$1.60 per share, which could allow them to pay a dividend of upwards of $1.50, or a ~50% increase above current levels. At an 8.0% yield on that dividend, we believe shareholders can return nearly nearly 60% over the next year from current levels. ($1.50 / 8% + $1.00 NTM divs = $19.75 value v ~$12.50 current)
Additionally, given that ACRE is still in the process of deploying the capital from the offering, we believe the probability of a further dilutive equity raise is minimal.
How we get to $1.35bn in total investments
ACRE’s equity base increased by a factor of ~2.5x due to the June equity raise. As we discussed above, ACRE uses wholesale financing to provide leverage on their equity. We believe the key to understanding ACRE is understanding the dollar amount of investments the company can make using their existing equity base. Since we have a sense of the interest rates on the loans they are originating, and the cost of funds on their wholesale borrowings, we can make an estimate as to how profitable ACRE can be on current equity base, assuming they fully deploy their capital.
To begin, we estimate that book value for ACRE post the offering will be $412mm (they will report on November 13). This is the total capital base from which ACRE can lever up and invest. It is important at this time to make the distinction that ACRE invests in both senior commercial mortgage loans as well as mezzanine loans. Additionally, ACRE owns Alliant, a multi-family originator/servicer. In our analysis, we assume that the assets of Alliant, and the mezzanine loan assets are not leverageable, other than with the existing convert that is already in place of $69mm. These assets in total account for ~$98mm of equity, netting out the convert. Therefore, we estimate the leveregeable equity at ACRE to be ~$315mm. This amount can be pledged as equity support to the senior loans that ACRE originates.
Est Q3 Book Value: $412mm
Less: Est Alliant Assets: ($61mm)
Less: Est Mezzanine Investments: ($106mm)
Add: Convert $69mm
Est Leverageable Equity: ~$315mm
As of currently, ACRE can leverage its investments in senior loans in two ways.
It is important to note that we believe that this securitization represents a substantial positive, which we don’t believe the market understands. This securitization allows for ACRE to receive higher advance rates, AND a lower cost than their legacy bank lines. The proceeds from the securitization will also go toward paying down the bank lines, so that they can be drawn again to fund future investments. Again, we believe this is a large positive that the market has overlooked.
So back to the math:
Using our ~$315mm of leverageable equity, we subtract the equity needed to support the securitization, or ~$99mm (the $494mm of investments less the $395mm of notes), and we arrive at $216mm of equity which can be levered through bank lines.
We believe this $216mm can support advance rates of ~70%. Therefore, we believe that this capital can support senior assets of $720mm.
We summarize this in the table below:
Est Leverageable Equity (from above): ~$315mm
Less: Est equity pledged to securitization: $99mm
Est Leverageable Equity for bank lines: $216mm
Est Advance rates for Sr Loans for bank lines: 70%
Est Investment Capacity from bank line equity: $720mm
Next, we add the estimated investment capacity from the bank line of $720mm to the investments pledged to the securitization of $494mm, and we arrive at ~$1.2bn of total senior investments, with ACRE fully-deploying their equity. We add to that the ~$100mm of mezzanine investments, and the ~$60mm investment in Alliant, to arrive at total investments of ~$1.35bn.
As an aside, the numbers above imply total debt of ~$956mm, which equates to ~2.3x equity. Management has outlined 2.0x to 2.5x as a range of debt to equity, so this provides a nice sanity check on the above math.
How we can get to a dividend of $1.50
At Q2 2013, ACRE had $627mm of Senior investments, yielding a blended rate of ~6.0%. We assume the ~$575mm of new Sr Investments ($1.2bn total Sr investments less the $627 current) yield ~5.5% (slight spread compression in light of general decline in rates over past few years), we arrive at our ~1.2bn of Sr Investments yielding a blended rate of ~5.8%. Adding the $100mm of mezzanine assets at an ~11.5% gets us to a total interest income of ~$81mm.
Assuming $395mm of securitization debt at 2.00% and ~$492mm of bank lines at 2.40% yields total Sr Debt of $887mm at a rate of ~2.22%, for a cost of ~20mm. Add in the $69mm convert, and the total interest cost is ~$26mm.
Therefore we calculate that fully-deployed net interest spread could be $55mm ($81mm interest income less $26mm int expense). From this we subtract management fees of 1.5% of the equity, or ~$6mm and est G&A expenses of ~$8mm, and add in est Alliant net income of ~$3.5mm to arrive at estimated Net Income of ~45mm, or $1.58 per share. We assume the vast majority of this is paid as a dividend, which is how we get to our ~$1.50 estimate of fully deployed pro forma annualized dividend per share.
We summarize this math in the table below:
Existing Sr Investments 627 6.0%
Est New Sr Investments 575 5.5%
Total Sr Investments 1200 5.8%
Mezzaninie Investments 100 11.5%
Total Investments (ex Alliant) 1300 6.2% (81mm interest income)
Bank Lines 492 (2.4%)
Securitization 395 (2.2%)
Convert 69 (9.0%)
Total Debt 956 (2.7%) (26mm interest expense)
Est Net Interest Income ~55.5mm
Mgmt Fees (6.0)
G&A Exp (8.0)
Alliant NI 3.5
Total Est NI ~45.0mm
Est EPS $1.58
Est Div $1.50
We believe ACRE offers the rare opportunity to invest in stable assets below book value, with potential for meaningful upside as the market understands the earnings potential of the company. We believe the securitization announced this morning should have served as a catalyst, and we are surprised that the market is not paying more attention (surprisingly, CRE has traded ~70k shrs today prior to this write up v normal ADV of ~290k). We believe that future catalysts exist in the form of earnings reports and investor communications, as the company continues to manage both sides of its balance sheet effectively while deploying the capital from the offering. Additional upside exists if the market understands that ACRE is actually asset sensitive, and the stock ceases to continue to trade like other REITs which are exposed to rising interest rates.
The author of this posting and related persons or entities ("Author") currently holds a long position in this security. The Author makes no representation that it will continue to hold positions in the securities of the issuer. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform Value Investors Club, the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The views expressed in this note are the only the opinion of the Author. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note
|Entry||11/05/2013 03:24 PM|
I think the best comp is BXMT, which I believe trades at a premium to book value.
|Entry||11/20/2013 08:18 PM|
Thanks v. much for the write-up. Curious whether you would change any assumption post the 3Q release? Would like to get your take on a few key levers in particular:
Investment base: Looking at $697mm (portfolio as of 9/30) + $500mm (mgmt guidance on available capacity for first mortgages), I arrived at $1,197 total investment base
Debt Load and Interest Expense: I assumed end-of-day secured facility balance of $375mm, based on mgmt comments of $150mm available capital, levered at 2.5x. As far as interest expense, do you have a view on how much expenses might push up the net rate?
Rate on new loans: I noticed that 3Q first mortgage originations yielded only ~4.6%, which appears a fairly significant decline from the previous avg rate.
G&A: Realize there may be some acquisition noise in these figures but I'm concerned G&A might be higher than the $8mm esp given the level of the 3Q nums.
Alliant earnings / MSRs: I liked some of the call commentary here and thought this has potential to be a bright spot-- it's a meaningful sized business and, at first glance, could be a large swing factor for the stock.
That all said, agree that the securization is a positive catalyst to biz model and stock... will be interesting to see if this gets more attention.
|Subject||RE: ACRE vs BXMT cage match?|
|Entry||08/13/2014 04:57 PM|
I own neither but I think you have to consider the difference in quality, expertise, and esteem that the market holds Mike Nash and the Blackstone team in vs. the 2nd and 3rd tier real estate professionals at Ares. The management team of Ares has a less than compelling pedigree. Second, Blackstone given their size and market cap can execute on much larger opportunities and has a much lower cost of debt capital. If you fail to account for these significant differences I suppose you could argue that the two companies should trade at a similar earnings yield or book value multiple. I however (and the market) view the the Blackstone team as an "A" team and the Ares team as a B- team (and B- is probably generous).