Description
Morguard Coporation: BUY
(Ticker: MRC CN; Recent Price: $32.50; Market Cap: $452.6
mm)
Even in a difficult
environment for commercial real estate, a real estate company trading at 7x
free cash flow stands out as a spectacular value. You would be surprised to
learn that this company is not a niche player but rather one of the largest
integrated real estate companies in Canada.
Morguard Corporation (“MRC”) owns
or manages nearly $9 billion of Canadian and US office, retail, residential and
industrial real estate assets spanning more than 42 million square feet. Despite the size of its operations, MRC
remains relatively unknown to investors as it has almost no research coverage
and does no investor calls or presentations. The CEO and owner of approximately
45% of MRC, Rai Sahi, is a self-made entrepreneur known for finding value in
underperforming companies or assets.
MRC recently announced its
intention to offer to buy in the 27.4% minority interest in Revenue Properties
(“RPC”), one of its operating subsidiaries. We believe that this transaction
will simplify MRC’s financial statements and make the value of the company more
readily apparent. More importantly, we believe this transaction is another
shrewd move by Rai Sahi to add shareholder value. He is taking advantage of the
weak market for real estate equities to buy the minority interest in RPC at a
10.7% trailing cap rate and for 6.9x its 2007 funds from operations (FFO), a
massive discount to its peers at 7.3% and 12.7x.
We believe that MRC trades at
more than a 50% discount to intrinsic value based on the FFO multiples and
adjusted funds from operations (AFFO) multiples of comparable companies. It
trades 5.0x 2007 FFO and 6.9x 2007 AFFO (pro forma the RPC transaction) versus
its peers at 12.7x and 14.8x respectively. At these market multiples, MRC would
trade at $82 and $69.
Company Overview
MRC conducts most of its
business through five wholly and partially owned subsidiaries.
It has two fee-based
subsidiaries.
·
Morguard
Investments (“MIL”)(100% owned) – MIL is a real estate investment advisory and
management services business serving major institutional and private investors.
It had $7.5 billion of assets under management as of 12/31/07.
·
Morguard
Financial (“MRF”)(100% owned) – MRF provides portfolio management services
specializing in real estate equities and income-producing investments. It had
~$200 million of assets under management as of 12/31/07.
MIL and MRF together
generated more than $17mm in fee income in 2007 after producing less than $10
million in 2006 as MIL increased its assets under management by 15%. We believe
these businesses are overlooked at MRC as they generate less than 15% of its
EBITDA. However, similar business garner more than 8x multiples.
MRC has three subsidiaries that
own commercial properties.
·
Morguard
REIT (“MRT”)(41.9% owned) – MRT is a publicly traded real estate investment
trust (MRT-U CN) with ~$750mm market cap that owns Canadian office, retail and
industrial properties. It has recently sold the majority of its industrial
properties to redeploy capital into office, retail and mixed-use properties. It
currently trades at a slight discount to its peer group at 11.1x (vs. 11.9x)
and 13.5x (vs. 14.0x) 2008E FFO and AFFO despite a similar modest growth
profile to its peers. MRC’s investment in MRT was consolidated until the fourth
quarter of 2006. Since then, it has been accounted for using the equity method.
MRC purchased shares during January 2008 to increase stake to 42.8%.
·
Revenue
Properties (72.6% owned) – RPC is publicly traded real estate company with
~$130mm market cap that owns retail, residential and office properties in
Canada and the US. It entered the US market in late 2006 with the
acquisition of Sizeler Property Investors, which doubled its net operating
income (NOI). Sizeler owned retail and apartment properties on the Gulf Coast.
The properties were poorly managed allowing RPC to buy them at a discount to
market and take advantage of opportunities for better property management. Both
the Canadian and US businesses have shown stable growth since the acquisition. MRC
recently announced an offer to purchase the remainder of RPC for $12 in cash or
1/3 of share of MRC per RPC share. We believe RPC to be worth approximately
double the $12 per share cash offer.
·
Morguard
Residential (“MRES”)(100% owned) – MRES owns 7,000 apartments and manages an
additional 3,000 apartments in Canada.
In addition to these
operations, MRC directly owns several non-residential assets including three
office towers and a stake in a shopping mall in Ontario. MRC’s wholly owned properties
(including RPC’s properties) produced $256.1 million and $140.9 million of
revenue and NOI in 2007.
Valuation
MRC could be evaluated versus
its peers based on its FFO and AFFO multiples or as a sum of four parts
(Morguard REIT, the fee-based businesses and the consolidated properties).
Either way, MRC’s market value vastly understates its intrinsic value.
Comparable Company
Analysis
|
|
FFO Multiple |
AFFO Multiple |
|
|
2007 |
2007 |
|
|
|
|
| MRC
Multiples |
5.0x |
6.9x |
|
|
|
|
| Canadian
Diversified REITs/Property Companies(1) |
|
| Averages |
|
12.7x |
14.8x |
| Min |
|
11.2x |
12.9x |
| Max |
|
15.1x |
18.0x |
|
|
|
|
| MRC FFO and
AFFO per Share(2) |
$
6.49 |
$
4.68 |
|
|
|
|
| Implied
MRC Price at Averages |
$
82.11 |
$
69.16 |
(1) Source: RBC Capital Markets. Companies include Allied Properties REIT,
Brookfield Properties, Calloway REIT, Cominar REIT, CREIT, Dundee REIT, First
Capital Realty, H&R REIT, InStorage REIT, Morguard REIT, Primaris Retail
REIT and RioCan.
(2)
Calculations
below:
| Reported FFO |
|
92,523 |
| Interest @ 6% on Incremental Debt |
|
(2,139) |
| for RPC Minority Interest Purchase |
|
|
| Pro Form FFO |
|
90,384 |
| Shares |
|
13,925 |
| Pro Form FFO per Share |
|
$ 6.49 |
| Pro Forma FFO |
|
90,384 |
| Maintenance Capital Expenditures |
|
(16,300) |
| Deferred Leasing Cost Additions |
|
(1,081) |
| Stepped Rent Adjustment |
|
(2,011) |
| Amortization of Below Market Leases |
|
(5,814) |
| Pro Forma AFFO |
|
65,178 |
| Shares |
|
13,925 |
| AFFO per Share |
|
$ 4.68 |
Sum of the Parts
We would conservatively value
MRC’s 41.9% stake in MRT at market ($315.6 million) despite MRT’s trading at a
slight discount to peers. We would value
the fee income using the average EBITDA multiple of public property management
companies. Then, we would value the current consolidated revenue producing
properties using the average cap rate of Canadian commercial REITs and property
companies. Finally, we would value all other assets and liabilities at book
value.
Comparable Fee-based Real
Estate Company Analysis
|
|
EBITDA Multiple |
|
|
2007 |
|
|
|
| CB Richard
Ellis |
8.1x |
| Grubb &
Ellis |
11.1x |
| WPCarey |
|
8.4x |
|
|
|
| Average |
|
9.2x |
| Min |
|
8.1x |
| Max |
|
11.1x |
|
|
|
| MRC Fee
EBITDA |
17,626 |
|
|
|
| Implied
Value at Average |
161,865 |
Comparable Canadian
REIT/Property Company Cap Rate Analysis
|
|
Cap Rate |
|
|
2007 |
|
|
|
| Canadian
Diversified REITs/Property Companies(1) |
|
| Average |
|
7.3% |
| Min |
|
6.0% |
| Max |
|
8.3% |
|
|
|
| MRC NOI |
|
140,865 |
|
|
|
| Implied MRC
Revenue-Producing Property Value |
1,936,894 |
(1) Source: RBC Capital Markets. Companies include Allied Properties REIT,
Brookfield Properties, Calloway REIT, Cominar REIT, CREIT, Dundee REIT, First
Capital Realty, H&R REIT, InStorage REIT, Morguard REIT, Primaris Retail
REIT and RioCan.
Sum of the Parts
| Morguard REIT at Market |
|
315,620 |
| Fee-based
Business at Average of Comps |
161,865 |
| Properties
at Average of Comps |
|
1,936,894 |
| Net Debt(1) |
|
|
(1,124,623) |
| MRC Equity
Value |
|
|
1,289,756 |
| Shares |
|
|
|
13,925 |
| MRC
Equity Value per Share |
|
$
92.62 |
(1) Pro forma for $35.7 million for the purchase of the 27.4% minority
interest in RPC. Calculation of net debt below:
| Debt |
|
|
|
Mortgages |
|
1,096,247 |
|
Notes Payable |
|
29,587 |
|
Construction Financing |
|
- |
|
Converts |
|
- |
|
Bank Debt |
|
178,079 |
|
|
|
|
| Total Debt |
|
1,303,913 |
|
|
|
|
| Cash |
|
29,644 |
| Restricted
Cash |
|
331 |
| Mortgage
and Loan Receivables |
|
40,964 |
| Assets Held
for Sale - Net Liabilities |
|
- |
| Land for
Development and Sale |
|
16,635 |
| Properties
for Development |
|
31,776 |
| Investments |
|
52,913 |
| Investment
in Direct Financing Lease |
|
7,027 |
| Total Cash
and Non-Revenue Producing Assets |
179,290 |
|
|
|
|
| Net Debt |
|
1,124,623 |
Issues
- Taxes. MRC is not a REIT; it pays corporate level
taxes. As a result, making comparisons with REITs is complicated. We
realize that accounting for taxes should mean that our valuation be
discounted. Any discount would have to make assumptions concerning when (or
if) taxes would be paid (e.g. MRC does not expect to pay US taxes in 2007
because of high levels of interest expense and amortization) and the tax
considerations of the investor.
- The Commercial Real Estate Market. The recent weakness in the North American
commercial real estate market could continue increasing the cap rates of
properties and lowering the multiples of public commercial real estate
companies. However, we note that Canadian property values did not escalate
nearly as much as US
property values from 2002 to 2006.
- Liquidity. MRC’s shares trade
rather infrequently. We think the discount to fair value on the shares
more than makes up for this.
- Potential Conflict of Interest. MRC
owns a 42.8% interest in MRT, and the two companies share a CEO.
Catalysts
- Completion of the RPC transaction
- Earnings reports with steadily increasing book
value
Bottom Line
The market does not know that this company exists
based upon its massively discounted valuation as compared to peers. MRC has
produced solid results in the past, and there is no reason to believe it will
not continue to do so in the future. Management takes a disciplined approach to
acquisitions and dispositions to their portfolio and have a growing fee-based
property management business. We recommend potential investors visit
www.morguard.com to see the extensive
market-by-market and sector-by-sector forecasts and overviews put out by the
management team.
Catalyst
* Completion of the RPC transaction
* Earnings reports with steadily increasing book value