|Shares Out. (in M):||65||P/E||0.0x||0.0x|
|Market Cap (in M):||1,400||P/FCF||0.0x||0.0x|
|Net Debt (in M):||0||EBIT||0||0|
Colony Financial (CLNY, $22.15) – a ‘sum of the parts’ story with a catalyst, levered to the housing recovery
Colony Financial is $1.4bn mkt cap real estate finance company with a materially undervalued asset in the single family rental space (SFR), Colony American Homes. That stake will be given a market reference price this week as the entity comes public (ticker CAHS). Over time, we expect Colony to divest this stake and return its focus to the commercial real estate space in which it excels. Colony Financial is the public market vehicle and source of permanent capital for Colony Capital, one of the best real estate PE firms in the world.
CLNY may seem fairly valued at first look (6.4% dividend yield; 1.1x BV) but its equity stake in CAHS is worth $11.20 per CLNY share at the mid-point of the IPO range. And CAHS does not currently distribute cash to CLNY. Net of CLNY's stake in CAHS, you can buy the CLNY stub at an effective 12.5% yield. If you hold for the ultimate monetization of CAHS and a re-rating of CLNY to a target 8% yield, you could make a 40% total return, or 25% annualized on a 1.5 year horizon, before assuming growth from leverage to a housing recovery.
Colony American Homes (CAHS)
Much has been written about the opportunities in the single family rental (SFR) space. In essence, pools of institutional capital have been raised opportunistically to take advantage of depressed prices and attractive financing. Colony Capital has raised $2.2bn of capital to date to invest in this space, of which $550mm came from the CLNY vehicle. They have been buying homes in AZ, CA, NV and increasingly in FL, with targets of 11% gross rental yields and 6% net of property taxes, insurance and other property management costs. Note that 6% yield is unlevered and doesn’t bake in any home price appreciation (HPA) or rising rental rates, it is simply their cash on cash return once the homes are renovated and leased up. Management expects to be able to get at least 50% leverage (i.e. Debt/Assets) with financing costs in the 3% range. This leads to a 9% levered yield before HPA and expectations of 3% rental rate increases – and will be the basis of an attractive dividend for this REIT.
CAHS is going public this week, pricing is expected to be $11.50-$13/share. CLNY’s stake in the entity represents $11/share of value at the midpoint of the price range. CLNY should own about 23% of CAHS following the IPO.
While a more detailed analysis is beyond the scope of this pitch, Colony expects CAHS to be one of the dominant SFR players in what is a scale business. The other large player is Blackstone, which has been plowing money into the space. There are also a few 2nd tier publicly traded players – SBY (spun out of Two Harbors), RESI (spun out of Altisource Portfolio Solutions) and ARPI (recent IPO). You would think this is a primarily a ‘local’ game, but there are clear economies of scale –e.g. cost of capital, purchasing building supplies for renovations etc. I think CAHS is coming out at close to fair value, so further upside in that entity would be based on management doing a great job executing on their strategy.
Colony Financial ex the Colony American Homes
If you look at CLNY stock using a simple screen on Bloomberg, without knowing about CAHS, you’d think it is probably fairly valued. It has a 6.4% dividend yield and trades at 1.1x book, which seems “reasonable” for what is primarily a commercial real estate lender. The reality, of course, is that the CAHS take is currently not helping support the dividend, so you are really creating the residual of CLNY at a 12.5% yield, which is very attractive.
The business model is pretty simple – Colony makes opportunistic real-estate debt and equity investments, either in high yielding originations and secondary loan acquisitions. They have their own 90+ person asset management team with significant NPL workout experience dating all the way back to the Resolution Trust Corp timeframe. As an example of the sorts of stuff they do, they were one the few players that were bidding for FDIC portfolios – where they typically received a 40% interest (FDIC kept 60%) but with 0% financing from the FDIC.
See their latest presentation
They look for high single digit to low double digit returns on assets and employ modest leverage to get to double digit ROEs. The reason they only use modest leverage is that they themselves often take more junior positions in the cap structure, such as sub debt or mezz loans at 60-80% LTV. CLNY’s primary liability is a $200mm 5% convert that matures in 2023. Note that as of 3/31 CLNY had $1.67bn of assets, so we are talking about a low Debt/Asset ratio (~20%) which is by design.
Background on Colony Capital
In the twenty-two years since its inception, Colony has invested in diverse and complex property, corporate, and portfolio transactions across five continents through varied economic cycles. Since inception Colony has invested $50 billion in over 22,000 assets/loans and has ~$25 billion of assets under management (gross) with more than 300 investor relationships. CEO, Thomas Barrack, got his start with the Bass family.
Valuation / Returns Profile
I look at this in two scenarios
(A) Holding period is thru year end ’13 – where the CAHS stake embedded in CLNY trades at a 35% discount to its public market value. The IPO lockup ends ins 6 months, which can lead to the beginning of secondaries or a tax free split to crystalize the value.
(B) Holding period through year end ’14 – should be enough time for CLNY to sell down its stake in CAHS. I apply a 10% discount to account for taxes and some liquidity discount. I do not include any capital appreciation or dividends from the CAHS stake
CLNY’s closest comps are NRF and STWD – they are trading at 8% dividend yield (have sold off a bit recently given the move in the 10yr benchmark rate). If you value the non SFR part of CLNY at an 8% yield, Scenario A yields a 30% IRR and Scenario B yields a 26% IRR. Note that this includes dividends along the way, but that those dividends aren’t themselves reinvested. On an absolute basis, I think a 550 bps spread to the 10 yr is reasonable for this sort of this business, and that would be a 7.6% yield at recent rates. At a 7.5% target yield, we are looking at a 30%+ IRR profile. On the downside case, at a punitive 10% dividend yield, Scenario B generates a 15% IRR to Dec ’14, and does marginally better than break-even in Scenario A.
For background on the comps
|Stock Px||$ 21.73|
|Scenario A - Hold through partial realization of value by YE '13, received June, Sept and Dec dvds|
|Dividend '13||Dvd Yield||Core Value||CAHS Discount||CAHS Value||Comb Value||% Appreciation||Dvd Received||% Tot Return||% IRR|
|$ 1.40||7.0%||$ 20.0||35%||$ 7.11||$ 27.11||25%||$ 1.05||30%||51.2%|
|$ 1.40||7.5%||$ 18.7||35%||$ 7.11||$ 25.78||19%||$ 1.05||23%||40.6%|
|$ 1.40||8.0%||$ 17.5||35%||$ 7.11||$ 24.61||13%||$ 1.05||18%||31.3%|
|$ 1.40||8.5%||$ 16.5||35%||$ 7.11||$ 23.58||9%||$ 1.05||13%||23.1%|
|$ 1.40||9.0%||$ 15.6||35%||$ 7.11||$ 22.67||4%||$ 1.05||9%||15.8%|
|$ 1.40||9.5%||$ 14.7||35%||$ 7.11||$ 21.85||1%||$ 1.05||5%||9.3%|
|$ 1.40||10.0%||$ 14.0||35%||$ 7.11||$ 21.11||-3%||$ 1.05||2%||3.4%|
|Scenario B - Hold thru monetization of stake by YE '14, receive 3 dvds in '12 and 4 in '13|
|Dividend '14e||Dvd Yield||Core Value||CAHS Discount||CAHS Value||Comb Value||% Appreciation||Dvd Received||% Tot Return||% IRR|
|$ 1.47||7.0%||$ 21.0||10%||$ 9.84||$ 30.84||42%||$ 2.52||54%||33.9%|
|$ 1.47||7.5%||$ 19.6||10%||$ 9.84||$ 29.44||36%||$ 2.52||47%||29.8%|
|$ 1.47||8.0%||$ 18.4||10%||$ 9.84||$ 28.22||30%||$ 2.52||41%||26.3%|
|$ 1.47||8.5%||$ 17.3||10%||$ 9.84||$ 27.14||25%||$ 2.52||36%||23.1%|
|$ 1.47||9.0%||$ 16.3||10%||$ 9.84||$ 26.18||20%||$ 2.52||32%||20.3%|
|$ 1.47||9.5%||$ 15.5||10%||$ 9.84||$ 25.32||17%||$ 2.52||28%||17.8%|
|$ 1.47||10.0%||$ 14.7||10%||$ 9.84||$ 24.54||13%||$ 2.52||25%||15.6%|
|Entry||06/04/2013 07:34 AM|
They haven't officially said they will sell / spin their stake. That is just my expecation having read their transcripts and how they view their strategy.
Specifically, I believe the Colony team simply thinks like private equity guys, which is make an investment, and look to 'harvest' a few years out as the loan matures or equity investment comes to a logical exit point. By contrast, CAHS is meant to be an 'ongoing concern' SFR REIT.
On their Q2 '12 conf call, they laid out their explanation for why they started buying these homes (i.e. the macro thesis) as well as why they subsequentlycontributed them into the entity which morphed into CAHS.
From the Q2-12 Conf call:
To begin, the U.S. single family residential market is arguably the largest macro distressed real estate investment
opportunity that emanated from the financial crisis. During the last four years, we've been living through the early
stages of a reversal of a long-lived credit bubble that affected all types of real and financial assets, particularly those
with high leverage. However, U.S. single family homes were plagued by both excessive leverage and over-building,
analogous to the same ingredients that led to the savings and loan crisis in the late 1980s, early 1990s, and the then
opportunity in commercial real estate.
Housing prices have declined an average of 35% nationally since the peak in 2006 and substantially more, as high as a 60% decline, in certain markets. Combined with the very strong demand for rental housing, primarily evidenced in the multi-family market, we are generally able to acquire homes at substantial discounts to replacement cost for net
stabilized rental yields in the 6% to 7% range on an unleveraged basis.
Interestingly, there has always been a cottage industry in single family rental that generally represented approximately 10% of the U.S. housing stock. However, it was an investment strategy based primarily upon a capital appreciation through rising home prices, and typically generated very low yields.
Furthermore, ownership historically was extraordinarily fragmented and dominated by individual local owners who
may own one or two homes. Approximately, 11 million homes out of the total U.S. single family market of 90 million homes are already owned and rented in this fashion. So, while single family homes are not a broad institutional asset class today, they do represent the single largest asset class in the U.S, with $20 plus trillion of value, and with an historic opportunity based on today's distress to transform part of this market and create a permanent institutional best-in-class business.
We expect net stabilized yields to grow from the imbalance of supply of multifamily and single-family rental stock
against growing rental demand from U.S. households. On the demand side, there appears to be a systemic shift in home ownership rates, having declined already to 65% from the peak of 69% just four years ago. And we expect this figure to drop further. As such, the number of renter households has steadily increased in the last few years and is expected to increase a the population grows. Coupled against low vacancy rates in the U.S multifamily stock and low housing starts, we expect rents to increase in the near and intermediate future. This strategy presents a great yield cash flow play with meaningful capital appreciation potential, and also possesses some attractive inflation hedge characteristics.
Lastly, it doesn't hurt that this strategy offers a politically friendly solution to the U.S. housing crisis and associated
impact on the broader economy. As of this week, our single-family joint venture had acquire approximately 1500
homes and has approximately 1200 homes in escrow across California, Arizona, Texas, Nevada, Colorado, and
Georgia. To our knowledge, we have already amassed one of the largest portfolios in the country and we intend to
remain a market leader with the size and scale that will provide us with a significant competitive advantage in the
In pursuit of that advantage, we recently committed to transfer our interests in single family homes to a newly formed investment vehicle managed by Colony Capital, whose sole purpose is to focus on single family ownership for rent at greater scale and diversity. As part of a larger portfolio of homes, we should benefit from economies of scale in terms of acquisition opportunities, renovation work and certain property management costs, potentially, better access to the private and public capital markets, which will provide more options to grow the business as well as more options for potential exit strategies. Within this entity, we do plan on utilizing a conservative amount of leverage to finance and grow our portfolio of homes, which should result in a higher cash yield on our equity. On a leveraged basis, we are underwriting our returns to exceed 20%. This return profile is a great complement to that of our existing debt portfolio. While risks remain, to be sure, primarily around getting to scale and proving out the operating model in our view, we believe the positives heavily outweigh the negatives. This investment strategy has the desirable qualities of both capital preservation and significant upside potential.
Capital preservation is achieved via buying homes at an attractive time in the housing cycle that can generate a
meaningful amount of current yield, and significant upside potential is realizable through accretive exit alternatives
where scale and operational efficiencies can be achieved. Another scenario, a less probable case, in our estimation, is that home price appreciation accelerates sharply again and renders the rental model uneconomic before we achieve scale. In this event, the investment strategy becomes just the profitable financial trade and not a permanent business opportunity, in our opinion.
As you can tell, we are very excited about the single family home strategy as well as the debt side of our business. The future of our company continues to be incredibly bright as we work to deliver equity returns with an attractive mix of debt and equity investments, all financed with a very conservative balance sheet.
|Subject||RE: CLNY's equity stake in CAHS|
|Entry||06/04/2013 11:43 AM|
We were told that CLNY's take in the equity of CASH is proportinal to its investment. So $550mm of capital they committed relative to $2.2bn total => 25% ownership pre-IPO
There are 228.6mm shares of CAHS before the IPO => CLNY owns 57.2mm shares then
CAHS valued at $12.25/share (IPO midpoint, we will see how it actually trades)
On 64mm CLNY shares that works out to $10.94/share to CLNY
The $11.20/share was a typo - I wrote $11 at one other point in the writeup.
|Subject||CAHS IPO postponed|
|Entry||06/05/2013 07:14 AM|
Looks like the CASH IPO is being postponed due to market conditions. Specifically, both the comps and REITs in general have continued to slide. I expect them to try again in the medium term.
|Entry||06/05/2013 07:17 AM|
Thanks for the idea.
You note that the CAHS stake is a hidden asset in terms of dvd yield as it contributes no cash flow. But in terms of book value, it is fully accounted for, correct?
As well, I am a bit confused by all the similar names, but the juicy mgmt fees of CAHS are going to a private company not owned in any way by CLNY, correct?
|Subject||RE: Question on shares|
|Entry||06/05/2013 09:54 AM|
gandalf, not my thread, but if you read the latest 8-k, you'll see that the final capital call just happened and they are now fully in for $550mm.
|Entry||06/05/2013 11:22 AM|
Yes, the initial capital they invested in CAHS is reflected in GAAP book value as an investment in an unconsolidated JV. That is correct.
However, it isn't marked to market, so the home price appreciation they have gotten certainly isn't reflected. Nor is that fact that this asset is worth a premium to book value.
As they start to generate cashflow / profits from their SFR investment, they can continue to raise the dividend. And ultimately, they will divest this asset.
|Entry||10/28/2013 05:21 PM|
They basically said that they are interested in bidding on a number of opportunities and needed dry powder. They had a good quarter (relative to street) so they have some credibility and may raise the dividend soon. The Homes asset is now contributing positive FCF.
|Subject||RE: RE: RE: Question|
|Entry||10/29/2013 03:48 PM|
They haven't given one. maybe it will be covered in the upcoming earnings call.
|Subject||RE: RE: Author Exit Recommendation|
|Entry||12/18/2013 08:52 AM|
Thesis break, deal fatigue, sea change in interest rates. Take your pick.