SILVER BAY REALTY TRUST CORP SBY
September 24, 2014 - 4:50pm EST by
straw1023
2014 2015
Price: 16.50 EPS $0.00 $0.00
Shares Out. (in M): 41 P/E 0.0x 0.0x
Market Cap (in $M): 672 P/FCF 0.0x 0.0x
Net Debt (in $M): 189 EBIT 0 0
TEV ($): 861 TEV/EBIT 0.0x 0.0x

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  • Potential Acquisition Target
  • Discount to NAV
  • Management Ownership
  • Management Internalisation
  • Industry Consolidation

Description

This is a simple two-part thesis. The first part protects against downside. The second provides the event-driven upside. The first part alone creates an interesting long-short trade, but it is part #2 that may make it compelling.
 
A caveat: I am not enamored by the single-family home business. It produces little cash flow, and I think monetizing the price appreciation is going to be messy and take a long time. I would recommend hedging with other single-family home funds, esp AMH (I am also short RESI).
 
Part #1: SBY trades cheap both to the NAV and to other single-family home funds. Irv Kessler, chairman, is the largest shareholder and a world-class investor. Now that his interests are aligned, he is not going to make shareholder unfriendly moves. 
 
Part #2: I think that Kessler intends to sell SBY in the near-term based on the investing environment and his recent internalization transaction. And I think that there are buyers out there (esp AMH) who would pay a premium to NAV for a large portfolio of already-rented, fixed-up homes. Due to recent securitization transactions and the small size of SBY, there is plenty of cash in funds earmarked for single-family homes to make this purchase.
 
 
-----
 
Valuation (Pro-forma for Internalization)
 
Shrs: 40.7mm * $16.50 = $672mm
 
Cash: $36mm
Debt: $225mm (note: does not include recent securitization)
 
TEV = $861mm. 
 
TBV = $644mm
 
TBV + D&A on homes = $675mm
 
TBV + D&A on homes + net increase in mkt value = $806mm --> $19.80/shr
 
Note that SBY has greater price appreciation than other funds for two reasons:
- They were first to the game (via predeccessors).
- They invested in some of the hardest hit areas that have also had the strongest gains.
 
AMH is the best comp (similar geographies and similar class of home ($175k average price)). As well, both now have internalized management so neither pays outsider fees.
 
AMH trades at a 10% premium to FMV while SBY trades at a 17% discount.
 
One big difference: AMH has 5.5x the number of houses as SBY (27k versus 6k).

-----
Background:

Kessler started Provident in 2010. It was a private fund (1% mgmt fee plus 20% over 8% hurdle) used to buy single family homes. It was completely unlevered. 

In late 2012, Kessler combined Provident with Two Harbor to form SBY. SBY was set up with the onerous external mgmt arrangement described below. 

As part of internalization, Kessler became Chairman, and he is the largest shareholder, with a bit less than 10% -- I cannot determine exact number of shares because I do not know how much of mgmt company he owns and cannot find in the docs. He owns about $60mm of shrs.
  

Why do I think Kessler wants to sell?
 
1) Most importantly, he converted his management fee into shares at a very low price. He had no self interest in doing this unless he intended to sell shortly. Kessler is a pretty well-known character in the industry and I think most people would agree he is smart, commercial, and a self-interested maximizer. He is a cold-blooded, self-interested profit maximizer. So why would he convert his management fee into shares at such a low cost?
 
The management fee was 1.5% of mkt cap per year plus pass-thru of all expenses. So the 1.5% was pure profit for the managers. Note as well that the mgmt agreement was virtually uncancellable!

"Following the initial term [mid December 2015], the management agreement may be terminated by us upon the affirmative vote of at least two-thirds of our independent directors based upon unsatisfactory performance that is materially detrimental to us."  -- from 10-K

So it could not be cancelled until December 2015. It could only be cancelled for cause. And if it was cancelled, SBY must pay a 4.5% of mkt cap termination fee! Just the termination fee plus the year-plus of fees was worth 6.5% of the mkt cap at the time of the internalization. Yet, Kessler closed it for 5.8%. Also note, that this analysis does not include any future capital raises, which would have added to the market cap and the management fee.
 
Why would Kessler want to internalize before selling SBY? Two reasons: he simplifies the structure and removes conflict of interest; and more importantly, he will now realize the price appreciation of his new shares.
 
2) The vehicle has become a dead vehicle. It produces little cash flow. They cannot raise equity financing without dilution. The results of SBY have fallen far short of the original results projected in the Provident pitch -- for several reasons, the projected cash flow has not happened and the yield on all these vehicles has been disappointing. So SBY is caught in no-man's land . . . it does not have scale to lower maintenance costs and due to its share price, it cannot raise capital. Note: due to securitization market, they can raise more money, but for next two reasons, I do not think Kessler wants that.
 
3) Kessler does not find houses cheap any longer. This is not where he wants his capital. SBY dramatically reduced home purchases in 2013. They said both that they were running low on capital and that they could not source houses as cheaply. But the first reason was a bit suspect as they could easily have levered further (even pre-securitization). When Kessler set up Provident, he said he planned on liquidating portfolio in 2016-2018 after prices appreciated to certain levels. Prices are now much closer to these "fair" levels than from where he started buying. 

4) Kessler does not like leverage, and with the recent securitization, the REIT is becoming quite levered. In the original Provident pitch, he repeatedly emphasized that there would be zero leverage used. Now, with prices much higher, they did a securitization of half their houses with a loan-to-value of 2/3. Kessler is an "arb" guy looking for the free money. I do not think he wants to take a levered bet on housing prices at this point.

Who would buy?
 
I think AMH is most likely buyer, but there are still lots of dollars out there dedicated to single-family home purchases. With recent securitization deals providing (shockingly) cheap financing on loan-to-values up to 75%, the funds are now awash again in cash. Note that buying SBY and then levering 2:1 would only require $400mm of equity capital. As an example, AMH just did two securitization for over $950mm on a fraction of the portfiolio and the pre-securitization debt load on the entire portfolio was $671mm. Obviously, these securitization are resulting in lots of leverage and lots of cash to buy new houses.

Further, AMH recently bought 1,300 homes from Beazer for 8.2mm shrs of stock so we are beginning to see consolidation.

The industry is ripe for consolidation for two major reasons. First, the smaller guys do not have the critical mass to lower maintenance costs. Second, the industry wants to prevent too many guys selling houses at the same time in the next five years.


What would someone pay?

Note that acquiring a similar portfolio as SBY would cost more than the $19.80 for three reasons: (1) basic liquidity (2) transaction costs and (3) there is a time and expense from purchase until house is ready to rent and then actually rented. Note that SBY's portfolio is almost all ready-to-rent and largely rented. I think that a buyer would be willing to pay from a 10% to 20% premium to $19.80 for these three reasons.
 


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

 SBY selling itself
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    Description

    This is a simple two-part thesis. The first part protects against downside. The second provides the event-driven upside. The first part alone creates an interesting long-short trade, but it is part #2 that may make it compelling.
     
    A caveat: I am not enamored by the single-family home business. It produces little cash flow, and I think monetizing the price appreciation is going to be messy and take a long time. I would recommend hedging with other single-family home funds, esp AMH (I am also short RESI).
     
    Part #1: SBY trades cheap both to the NAV and to other single-family home funds. Irv Kessler, chairman, is the largest shareholder and a world-class investor. Now that his interests are aligned, he is not going to make shareholder unfriendly moves. 
     
    Part #2: I think that Kessler intends to sell SBY in the near-term based on the investing environment and his recent internalization transaction. And I think that there are buyers out there (esp AMH) who would pay a premium to NAV for a large portfolio of already-rented, fixed-up homes. Due to recent securitization transactions and the small size of SBY, there is plenty of cash in funds earmarked for single-family homes to make this purchase.
     
     
    -----
     
    Valuation (Pro-forma for Internalization)
     
    Shrs: 40.7mm * $16.50 = $672mm
     
    Cash: $36mm
    Debt: $225mm (note: does not include recent securitization)
     
    TEV = $861mm. 
     
    TBV = $644mm
     
    TBV + D&A on homes = $675mm
     
    TBV + D&A on homes + net increase in mkt value = $806mm --> $19.80/shr
     
    Note that SBY has greater price appreciation than other funds for two reasons:
    - They were first to the game (via predeccessors).
    - They invested in some of the hardest hit areas that have also had the strongest gains.
     
    AMH is the best comp (similar geographies and similar class of home ($175k average price)). As well, both now have internalized management so neither pays outsider fees.
     
    AMH trades at a 10% premium to FMV while SBY trades at a 17% discount.
     
    One big difference: AMH has 5.5x the number of houses as SBY (27k versus 6k).

    -----
    Background:

    Kessler started Provident in 2010. It was a private fund (1% mgmt fee plus 20% over 8% hurdle) used to buy single family homes. It was completely unlevered. 

    In late 2012, Kessler combined Provident with Two Harbor to form SBY. SBY was set up with the onerous external mgmt arrangement described below. 

    As part of internalization, Kessler became Chairman, and he is the largest shareholder, with a bit less than 10% -- I cannot determine exact number of shares because I do not know how much of mgmt company he owns and cannot find in the docs. He owns about $60mm of shrs.
      

    Why do I think Kessler wants to sell?
     
    1) Most importantly, he converted his management fee into shares at a very low price. He had no self interest in doing this unless he intended to sell shortly. Kessler is a pretty well-known character in the industry and I think most people would agree he is smart, commercial, and a self-interested maximizer. He is a cold-blooded, self-interested profit maximizer. So why would he convert his management fee into shares at such a low cost?
     
    The management fee was 1.5% of mkt cap per year plus pass-thru of all expenses. So the 1.5% was pure profit for the managers. Note as well that the mgmt agreement was virtually uncancellable!

    "Following the initial term [mid December 2015], the management agreement may be terminated by us upon the affirmative vote of at least two-thirds of our independent directors based upon unsatisfactory performance that is materially detrimental to us."  -- from 10-K

    So it could not be cancelled until December 2015. It could only be cancelled for cause. And if it was cancelled, SBY must pay a 4.5% of mkt cap termination fee! Just the termination fee plus the year-plus of fees was worth 6.5% of the mkt cap at the time of the internalization. Yet, Kessler closed it for 5.8%. Also note, that this analysis does not include any future capital raises, which would have added to the market cap and the management fee.
     
    Why would Kessler want to internalize before selling SBY? Two reasons: he simplifies the structure and removes conflict of interest; and more importantly, he will now realize the price appreciation of his new shares.
     
    2) The vehicle has become a dead vehicle. It produces little cash flow. They cannot raise equity financing without dilution. The results of SBY have fallen far short of the original results projected in the Provident pitch -- for several reasons, the projected cash flow has not happened and the yield on all these vehicles has been disappointing. So SBY is caught in no-man's land . . . it does not have scale to lower maintenance costs and due to its share price, it cannot raise capital. Note: due to securitization market, they can raise more money, but for next two reasons, I do not think Kessler wants that.
     
    3) Kessler does not find houses cheap any longer. This is not where he wants his capital. SBY dramatically reduced home purchases in 2013. They said both that they were running low on capital and that they could not source houses as cheaply. But the first reason was a bit suspect as they could easily have levered further (even pre-securitization). When Kessler set up Provident, he said he planned on liquidating portfolio in 2016-2018 after prices appreciated to certain levels. Prices are now much closer to these "fair" levels than from where he started buying. 

    4) Kessler does not like leverage, and with the recent securitization, the REIT is becoming quite levered. In the original Provident pitch, he repeatedly emphasized that there would be zero leverage used. Now, with prices much higher, they did a securitization of half their houses with a loan-to-value of 2/3. Kessler is an "arb" guy looking for the free money. I do not think he wants to take a levered bet on housing prices at this point.

    Who would buy?
     
    I think AMH is most likely buyer, but there are still lots of dollars out there dedicated to single-family home purchases. With recent securitization deals providing (shockingly) cheap financing on loan-to-values up to 75%, the funds are now awash again in cash. Note that buying SBY and then levering 2:1 would only require $400mm of equity capital. As an example, AMH just did two securitization for over $950mm on a fraction of the portfiolio and the pre-securitization debt load on the entire portfolio was $671mm. Obviously, these securitization are resulting in lots of leverage and lots of cash to buy new houses.

    Further, AMH recently bought 1,300 homes from Beazer for 8.2mm shrs of stock so we are beginning to see consolidation.

    The industry is ripe for consolidation for two major reasons. First, the smaller guys do not have the critical mass to lower maintenance costs. Second, the industry wants to prevent too many guys selling houses at the same time in the next five years.


    What would someone pay?

    Note that acquiring a similar portfolio as SBY would cost more than the $19.80 for three reasons: (1) basic liquidity (2) transaction costs and (3) there is a time and expense from purchase until house is ready to rent and then actually rented. Note that SBY's portfolio is almost all ready-to-rent and largely rented. I think that a buyer would be willing to pay from a 10% to 20% premium to $19.80 for these three reasons.
     


    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

     SBY selling itself
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