COLE REAL ESTATE INVESTMENTS COLE
October 06, 2013 - 7:16pm EST by
Ragnar0307
2013 2014
Price: 12.24 EPS NA NA
Shares Out. (in M): 469 P/E NA NA
Market Cap (in M): 5,745 P/FCF 13.6x 12.5x
Net Debt (in M): 3,153 EBIT 0 0
TEV: 8,916 TEV/EBIT NA NA

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  • Triple net REIT
  • M&A Catalyst
  • Analyst Coverage
 

Description

 

Business Description

Cole Real Estate is a triple net lease REIT.  It manages a $7.5B portfolio comprised of 1,014 properties that are geographically diversified.  The portfolio is 55% investment grade and has an average lease duration of 12.2 years.  The industry mix is 68% retail, 18% office, 7% industrial, and 7% other.  The top three tenants are Walgreens, Albertsons, and Petsmart.  The top three sub-industries are grocery, drugstore, and discount stores.

What is triple net?  Triple net is a lease structure where essentially all costs are passed onto the tenant (taxes, insurance, maintenance, opex, etc.).  The tenants typically sign longer term leases with low annual rent escalators.  Credit risk is typically the most important metric to track since the main risk to occupancy is tenant bankruptcy or distress.  Triple nets are very easy to model - AFFO or cash flow will essentially be unchanged quarter to quarter excluding M&A.

In addition to its internal portfolio, Cole has a Private Capital business that manages $3.1B of real-estate assets in several non-traded private REITs.  The Private Capital business generates about 10-15% of Cole's AFFO.  Cole currently has three open non-traded REITs: CCPT IV (focused on single tenant and multi tenant retail), CCIT (focused on single tenant office and industrial), and INAV (no industry focus).  Cole earns money in this business from offering fees, transaction fees, management fees, and incentive fees.  The REITs usually have a 2-3 year life and then some type of liquidity event.

The core business benefits from the Private Capital business because it provides it with M&A expertise and scale.  Despite only being public for a few months, Cole has been in the triple net lease business for decades.  Since inception, it has deployed $14B of capital.  Over time, Cole has proved to be a better acquirer of properties than its peers.  Unlike many of its competitors, Cole tries to buy single assets instead of portfolios because they are cheaper to acquire.  It also only sources about half of its properties from brokers, which helps keep prices lower.  As a result, Cole has been able to consistently acquire properties at a higher cap rate than the industry average (8-8.5% vs. 7-7.5% according to Real Capital Analytics).

Link to investor presentation, which provides a good overview of the company: http://ir.colereit.com/file.aspx?IID=4200055&FID=1500050291

Investment Thesis

Until 2Q13, Cole was a private external REIT manager.  Then in 2Q13, Cole merged with one of its private non-traded REITs (CCPT III).  After it merged, the new entity was owned by retail investors who owned CCPT III prior to the merger and the owners of Cole (mostly Chris Cole).  In late June, Cole decided to list on the NYSE to give its 100,000+ retail investors liquidity.  After years of illiquidity, many of these investors started to sell, which caused a lot of selling pressure and volatility in the stock.  To alleviate selling pressure, Cole tendered for $250MM of shares in August and authorized a $250MM buyback.  Because of this technical overhang, Cole still trades at a meaningful discount to its peers despite an arguably better portfolio of assets.  Cole trades at 12.5x AFFO vs. its closest peer O at 15.8x AFFO.  On the surface, this relative value gap may not seem that compelling, however, there are several catalysts over the next 6 months that should close the gap and may even cause Cole to trade at a premium.  These catalysts include:

  • Increased sell-side coverage.  Cole is a $5.7B market cap company that had zero sell-side coverage until about a month ago.  O and NNN are close comps and each have 10+ analysts covering them.  Given the discount relative to O and NNN, I expect most analysts will initiate positively.  Cole currently has three analysts covering it (Ladenburg, JMP, and FBR), but all of them are boutique banks.  Management is hoping to get a bulge bracket bank to pick up coverage by year-end.
  • Index inclusion.  Over the past month, Cole was added to several FTSE NAREIT, Dow Jones, and S&P real-estate indices.  Eventually, I expect Russell to add Cole to its indices.  These additions will cause forced buying by index funds and "closeted" index funds.
  • Increased marketing by mgmt due to HUGE incentives.  Management marketed aggressively this summer and plans for another road show after 3Q earnings.  If management gets the stock 35% higher within the next 4 months, they will earn up to $330MM!  This incentive will be paid to Chris Cole, but he will likely share it with the rest of the management team.  After speaking with the company, it is clear that everyone is aware of this incentive and is doing whatever they can to market the story.  If Cole trades in-line with O within the next few months, most of this gap will be closed and management will earn most of their money.  ARCT (previously written up on VIC) had a similar incentive/event path and was eventually taken out by O.  It's also interesting to note that management received an offer of $13.59 for CCPT III in March and turned it down.  They are clearly focused on achieving the high-end of the incentive payout by getting the stock up to $16.50 per share and were not interested in settling for $13.59, which would have only earned them $165MM of their payout.  The incentive will be measured using the volume weighted average price from 12/14/13 to 1/30/14 or about 3-4 months from today.  Link to an overview of management's incentives: http://ir.colereit.com/file.aspx?iid=4200055&fid=1001177911
  • Investment grade rating.  Cole currently meets 11 of 13 of Moody's key criteria for investment grade.  The two areas it needs to improve are the % of unencumbered assets and the amount of secured debt.  Once it achieves an investment grade rating, Cole will become more investable for REIT investors.  In addition, its cost of capital will improve which will make acquisitions more accretive.
  • Accretive aquisitions.  REIT investors are very focused on AFFO and dividend growth.  For triple nets, the main source of growth is M&A.  Cole hopes to acquire ~$500MM of properties in 2H.  Next year, it could potentially acquire CCIT, one of its private non-traded REITs that is about to close to new investors and pursue strategic alternative (i.e. liquidity).  This would add nearly $1B of new property to Cole's portfolio.  Cole is best positioned to acquire this portfolio because it knows it the best and it does not have to pay an incentive fee since it will come out of one pocket and go into another.
  • Full year of merged financials / more public history.  Cole has only reported one quarter of fully merged financials.  As Cole reports more quarters, REIT investors will become more comfortable with the story.

Price Target

At 16x AFFO, there is 30% upside in the stock.  Given management's incentives and the catalysts, I think we could see this return in the next 6 months.

Interest rates rising is the biggest risk to this investment.  Because Cole is a triple net, it has higher exposure to rising interest rates (longer duration assets).  I recommend shorting O or NNN to hedge this risk.  O is probably the most similar comp.

Comps

Comps

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Increased sell-side coverage.
  • Index inclusion.
  • Increased marketing by mgmt due to HUGE incentives.
  • Investment grade rating.
  • Accretive acquisitions.
  • Full year of merged financials / more public history.
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    Description

     

    Business Description

    Cole Real Estate is a triple net lease REIT.  It manages a $7.5B portfolio comprised of 1,014 properties that are geographically diversified.  The portfolio is 55% investment grade and has an average lease duration of 12.2 years.  The industry mix is 68% retail, 18% office, 7% industrial, and 7% other.  The top three tenants are Walgreens, Albertsons, and Petsmart.  The top three sub-industries are grocery, drugstore, and discount stores.

    What is triple net?  Triple net is a lease structure where essentially all costs are passed onto the tenant (taxes, insurance, maintenance, opex, etc.).  The tenants typically sign longer term leases with low annual rent escalators.  Credit risk is typically the most important metric to track since the main risk to occupancy is tenant bankruptcy or distress.  Triple nets are very easy to model - AFFO or cash flow will essentially be unchanged quarter to quarter excluding M&A.

    In addition to its internal portfolio, Cole has a Private Capital business that manages $3.1B of real-estate assets in several non-traded private REITs.  The Private Capital business generates about 10-15% of Cole's AFFO.  Cole currently has three open non-traded REITs: CCPT IV (focused on single tenant and multi tenant retail), CCIT (focused on single tenant office and industrial), and INAV (no industry focus).  Cole earns money in this business from offering fees, transaction fees, management fees, and incentive fees.  The REITs usually have a 2-3 year life and then some type of liquidity event.

    The core business benefits from the Private Capital business because it provides it with M&A expertise and scale.  Despite only being public for a few months, Cole has been in the triple net lease business for decades.  Since inception, it has deployed $14B of capital.  Over time, Cole has proved to be a better acquirer of properties than its peers.  Unlike many of its competitors, Cole tries to buy single assets instead of portfolios because they are cheaper to acquire.  It also only sources about half of its properties from brokers, which helps keep prices lower.  As a result, Cole has been able to consistently acquire properties at a higher cap rate than the industry average (8-8.5% vs. 7-7.5% according to Real Capital Analytics).

    Link to investor presentation, which provides a good overview of the company: http://ir.colereit.com/file.aspx?IID=4200055&FID=1500050291

    Investment Thesis

    Until 2Q13, Cole was a private external REIT manager.  Then in 2Q13, Cole merged with one of its private non-traded REITs (CCPT III).  After it merged, the new entity was owned by retail investors who owned CCPT III prior to the merger and the owners of Cole (mostly Chris Cole).  In late June, Cole decided to list on the NYSE to give its 100,000+ retail investors liquidity.  After years of illiquidity, many of these investors started to sell, which caused a lot of selling pressure and volatility in the stock.  To alleviate selling pressure, Cole tendered for $250MM of shares in August and authorized a $250MM buyback.  Because of this technical overhang, Cole still trades at a meaningful discount to its peers despite an arguably better portfolio of assets.  Cole trades at 12.5x AFFO vs. its closest peer O at 15.8x AFFO.  On the surface, this relative value gap may not seem that compelling, however, there are several catalysts over the next 6 months that should close the gap and may even cause Cole to trade at a premium.  These catalysts include:

    Price Target

    At 16x AFFO, there is 30% upside in the stock.  Given management's incentives and the catalysts, I think we could see this return in the next 6 months.

    Interest rates rising is the biggest risk to this investment.  Because Cole is a triple net, it has higher exposure to rising interest rates (longer duration assets).  I recommend shorting O or NNN to hedge this risk.  O is probably the most similar comp.

    Comps

    Comps

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    • Increased sell-side coverage.
    • Index inclusion.
    • Increased marketing by mgmt due to HUGE incentives.
    • Investment grade rating.
    • Accretive acquisitions.
    • Full year of merged financials / more public history.

    Messages


    SubjectImplied Cap Rate?
    Entry10/06/2013 10:38 PM
    Membernha855
    For those of us who prefer enterprise value based valuation metrics, can you please tell me the implied cap rate of COLE at today's price and how that compares to peers? Thank you

    SubjectA couple questions
    Entry10/07/2013 09:59 AM
    Membersnarfy
    Thanks for sharing.
     
    1.  Do you know the size of the potential acquisition universe of triple net lease properties?
    Just trying to get a sense for how big the growth runway is.
     
    2.  How would you compare COLE to ARCP?
     
     

    SubjectARCP vs. COLE
    Entry10/07/2013 10:49 AM
    Membereal820
    Thoughts on why the trade say since early Aug (COLE vs. NNN/O -both long and short end of trade actually worked) has worked but not if did ARCP (has not worked and has more traded with pack)? Did something happen? How would you characterized major difference between ARCP and COLE?

    SubjectRE: Implied Cap Rate?
    Entry10/07/2013 11:54 AM
    MemberRagnar0307
    I calculate Cole trades at a 2013 implied cap rate of 6.9% vs. O at 5.8% and NNN at 6.3%.  On 2014 numbers, Cole trades at 7.9% vs. O at 6.6% and NNN at 6.9%.

    SubjectRE: payout ratio
    Entry10/07/2013 11:57 AM
    MemberRagnar0307
    Cole mgmt only wants to use real-estate earnings to pay a dividend.  It does not want to use earnings from its Private Capital business.  If you adjust for this, the dividend payout is ~92%.

    SubjectCredit Risk?
    Entry10/07/2013 01:40 PM
    MemberDrew770a
    Albertson's bonds at 10%+ seem to be implying potential bad things to come.  How much exposure do they have to grocery in general, what do you think is the downside and is there much alternative use for some of these higher risk properties? tx

    SubjectRE: RE: Implied Cap Rate?
    Entry10/07/2013 02:30 PM
    Membernha855
    Why will NOI increase so much in 2014?

    SubjectRE: ARCP vs. COLE
    Entry10/07/2013 04:15 PM
    MemberRagnar0307

    I have not spent a ton of time on ARCP, but here are some thoughts:

    • ARCP is more aggressive and acquisitive.  They have been going after large portfolios and are paying high prices, while Cole has been more focused on single assets/small portfolios.  It feels to me like ARCP is an empire builder.  Cole is much more disciplined with acquisitions.  They weigh stock buybacks against each acquisition they make and have a very long history of being good acquirers over time.
    • Better incentives at Cole.  Cole's mgmt team has a great near-term incentive with the $330MM payout.  I really like this part of the thesis and ARCP does not have this explicit payout.  That said, ARCP mgmt does own a lot of stock.
    • Cole has already internalized its mgmt.  ARCP has not.
    • I think Cole's Private Capital business will help differentiate it over the long run (see write-up above).
    • Anecdotally, I've heard from sell-side analysts that ARCP's portfolio is worse quality than Cole's.

    To summarize, I think they are very similar situations, but I like Cole better because of the quality of mgmt/capital allocation and the extra catalyst with the mgmt incentive payout.


    SubjectRE: Credit Risk?
    Entry10/07/2013 06:35 PM
    MemberRagnar0307

    Grocery is one of Cole's biggest sectors.  It accounts for 9.1% of rental revenue (4.2% Albertson's).  O has 3.2% grocery so being short this will partially help hedge the risk.  I don't think grocery is going away, but retailers like Walmart and Target are definitely taking share.  In general, I think of Cole as a pair trade vs. O and NNN so you will be short a bunch of riskier credits to offset the riskier credits you own.  It obviously won't be perfect, but it's better than being naked long.

    I would also point out that Ackman was short O in 2009 because of its bad credit risk.  He was worried about their discretionary retail exposure.  Occupancy was ~97% at the time.  It fell 1%.  Occupancy for O has averaged 98% since 1970 and has never fallen below 96%.  Link to Ackman's presentation: http://www.marketfolly.com/2009/10/ackman-pershing-squares-realty-income-o.html


    SubjectRE: RE: RE: Implied Cap Rate?
    Entry10/07/2013 06:51 PM
    MemberRagnar0307

    The NOI numbers I used to calculate the cap rates are consensus sell-side numbers.  Like I said above, the vast majority of growth is driven by M&A.  Modeling the business going forward is entirely dependent on your assumptions for future M&A.

    That said, there will be modest organic growth.  Real-estate (85% of company) top-line will probably grow 1-2%, which will translate into low-to-mid single digit bottom line growth.  There will also likely be some growth in the Private Capital business (15% of company), which has raised more money this year than it has in the past 5 years.  Link to presentation with capital raise update: http://ir.colereit.com/file.aspx?IID=4200055&FID=1001179316


    SubjectMgmt Incentive / Upcoming Marketing Schedule
    Entry10/08/2013 10:31 AM
    MemberRagnar0307
    Mgmt is planning heavy marketing ahead of the upcoming incentive, which will be measured from 12/17-1/30:
    • 1st Week of November (post earnings) - NYC
    • 2nd Week of November - San Fran for NAREIT
    • 3rd Week of November - Chicago
    • 4th Week of November - Thanksgiving
    • 1st and 2nd Week of December - Boston, Connecticut, NYC, and Philly

    SubjectRE: A couple questions
    Entry10/08/2013 10:42 AM
    MemberRagnar0307
    snarfy,
     
    In response to your first question...honestly, I have not come across any great way to gauge the size of the net lease acquisition universe.  Most of it is held privately.  Real Capital Analytics sized the transaction market at $150B in 2012, but it's unclear if they include large portfolio deals (like Cole merging with CCPT III) and they do not include deals smaller than $3MM, which actually has an impact since many deals are for single assets.  For what it's worth, mgmt teams across the space have not voiced concerns about supply drying up and are actually quite bullish about the amount of supply out there to acquire.  One thing they've talked about is the potential for a lot of corporate real-estate to come onto the market over the next couple years.
     
    If supply does dry up, Cole is advantaged because they are natural acquirers of property from their Private Capital business since they know it the best and don't have to pay an incentive fee/promote, which means the ultimate cap rate they pay will be 50-100 bps higher in many cases.

    SubjectRE: RE: A couple questions
    Entry10/08/2013 01:27 PM
    MemberRagnar0307
    snarfy,
     
    Morgan Stanley was out with a broker survey this morning on the net lease space titled "Triple Net REIT Insights: Brokers More Bullish On Deals, See Flat Cap Rates."  It's worth a read.  Some takeaways include:
    • "Deal pipelines across the board are generally stronger than they were three months ago with non-investment grade retail showing the most improvement."
    • "Roughly 55% of brokers expect deal pipelines to be up in the coming months compared to 40% in our last survey.  Only 10% expect declines compared to 20% in July."

    SubjectRE: RE: RE: A couple questions
    Entry10/08/2013 04:29 PM
    Membersnarfy
    Thanks for the heads up on that report and thanks for your earlier replies.

    Subjectcongrats!
    Entry10/23/2013 10:48 AM
    Membersurf1680
    Thanks for posting this!  
     
    This is the 2nd successful vic idea i've paired with a short of O ("THE dividend stock")!
     

    Subjectwell played
    Entry10/24/2013 01:12 AM
    Memberhkup881
    No comment. Just job well done!!
     
    Actionable ideas are the reason for VIC

    SubjectIt's Even Better Now.
    Entry10/24/2013 06:46 PM
    Memberarcher610
    I think that COLE is the cheapest and most compelling value that its ever been.
     
    I have been involved in this situation and liked it for a while, and in my view, COLE sets up much better now than when this was posted.  
     
    PF for the deal you are creating ARCP + COLE a 7.7% dividend yield (1.092 per share) and trading at about 11.2x AFFO PF for this transaction closing.  It will be the biggest triple-net REIT, and have comparable asset quality to the peer set.  So there is now 40% to 50% upside to the comps on each of these metrics that you looked at in this write-up.
        

    SubjectRE: It's Even Better Now.
    Entry10/24/2013 10:26 PM
    MemberRagnar0307
    I agree.  The stock is now cheaper vs. its peers and it is too big for the sell-side and institutional investors to ignore.  It is still very underfollowed vs. other large cap REITs (5 analysts vs. 20+).  It will also likely be included in the S&P 500 index and will be one of the highest yielding stocks in the index at 7.5%.  The only negative is that the mgmt incentive is not as clean and I do not like the CEO of ARCP relative to Cole.  He's too promotional and aggressive.  Chris Cole and Marc Nemer are also moving on, which is a negative, but apparantely they have 5-year non-competes and will keep their equity for a set period of time, which I guess is a postive.  Bottom line, I'm holding the stock here.

    SubjectRE: RE: congrats!
    Entry10/24/2013 10:28 PM
    MemberRagnar0307
    Thanks!  Unfortunately I do not own any other stocks with this type of mgmt incentive, but I'm also very interested if anyone is aware of similar situations.

    SubjectRE: RE: RE: RE: congrats!
    Entry10/25/2013 05:48 PM
    MemberRagnar0307
    Yes, probably unlikely.  One sell-sider was speculating O could come in, but I doubt it.  People know better than to get in a bidding war with Schorsch.

    SubjectRE: RE: RE: RE: RE: RE: congrats!
    Entry10/26/2013 04:21 PM
    Memberarcher610
    The gap between relevant peers and ARCP / COLE is as wide as its ever been.  At this point there is 50%+ upside.  Even if the gap only goes to where it was prior to the deal there is still 25%+ upside.  ARCP is likely to get significant sellside coverage shortly given its size.  Also based on my research it is likely to be a very strong candidate to be in the S&P.  There are no other sizeable REITs trading at anything less than a 15% premium to this one that I know of.  
     
    It is a little strange to extrapolate one day of trading (Friday) as evidence that it is going to underperform.  Though it is undoubtedly positive on an absolute basis if the comps keep going up, and I am certainly not bearish on the sector.  

    SubjectRE: RE: RE: RE: RE: RE: RE: congrats!
    Entry10/27/2013 07:40 AM
    Memberjuice835
    thanks for all the thoughts on this. what do you think the difference in implied cap rates is here between PF ARCP / COLE and O & NNN? trying to figure out how much of the AFFO multiple discount is simply a function of the PF entity having more leverage than the comps.

    SubjectRE: RE: RE: RE: RE: RE: RE: RE: congrats!
    Entry10/29/2013 12:04 PM
    MemberRagnar0307
    I'm calculating that the PF entity trades in the mid-to-high 6s vs. O which is in the high 5s.

    SubjectRE: Pro Forma ARCP/COLE
    Entry12/16/2013 03:32 PM
    MemberRagnar0307

    I still like COLE/ARCP pro forma.  It's cheap relative to its peers (ARCP trades at 11.0x AFFO vs. O and NNN at 15.0x) and there are several hard and soft catalysts that will help close the gap over the next 6-12 months.  These include:

    • Increased sell-side coverage.
    • Clean financials / deal closes. The ARCP story has been overly complicated for too long because of all the deals. I think a cleaner story will do a lot for the stock.
    • Potential S&P 500 inclusion.  ARCP will be one of the highest yielding stocks in the entire index.
    • Dividend increase.

    SubjectRE: RE: RE: Pro Forma ARCP/COLE
    Entry01/11/2014 12:27 PM
    MemberRagnar0307
    Like I said in my below comment, I still like it.  It's still cheap relative to peers with several soft catalysts.  It's also nice to see that mgmt expects to see the COLE deal close by the end of January (2 months earlier than expected) and has successfully transitioned to self mgmt.

    SubjectRE: RE: RE: RE: RE: Pro Forma ARCP/COLE
    Entry01/11/2014 09:37 PM
    Memberrasputin998
    I'm also curious if anyone here has any thoughts on the ARCPP prefs.   6.7 coupon trading at 20.45 for 25 par yielding 8.2%.  Insiders were buying last week.
     

    SubjectRE: RE: RE: RE: RE: Pro Forma ARCP/COLE
    Entry01/13/2014 10:14 AM
    MemberRagnar0307
    Near-term, I do think there is some merit to the gap persisting because of the amount of complication, but I think the gap will compress as the story becomes simpler over the next 6-9 months.  If you are really bullish, you could even argue for a premium at some point due to the Private Capital business, which gives them a competitive advantage.  I think it's too early for that though.

    SubjectRE: RE: RE: RE: RE: RE: Pro Forma ARCP/COLE
    Entry01/13/2014 10:15 AM
    MemberRagnar0307
    No specific thoughts, but I saw the same thing as you.  Lots of insider buying.
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