|Shares Out. (in M):||50||P/E||0.0x||0.0x|
|Market Cap (in $M):||209||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
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Thomas Properties (TPGI; the "Company") is a real estate operating company with a strong balance sheet, negligible recourse leverage, and positive cash flow, yet the stock trades at a large discount to an easily determined NAV that mostly consists of net cash and equity stakes in three class-A metro properties. The Company is preserving and creating shareholder value through recent wise decisions to distribute excess cash to shareholders via a quarterly dividend and to divest fully-valued non-core properties. Chairman and CEO Jim Thomas owns c 30% of the stock and has strong incentives to maximize value although, he may do so at his own pace. The Company plans to redeploy the proceeds from recent asset sales into new core plus and value-added properties. This would increase the distributable cash flow of the Company to support a larger dividend and potential conversion to REIT status. We believe that these steps will serve as a catalyst for a revaluation of the stock as the yield and dividend draw the attention of more traditional income-orientated real estate investors. In the meantime, given the strong balance sheet and discount to NAV we believe that there is limited risk of permanent capital loss.
Thomas Properties is a fully integrated real estate platform with ownership interests in 22 operating properties across the US as well as asset management and development arms that perform fee-based services. The Company is also the GP in a stand-alone investment JV with CalSTRS in which it is entitled to management fees and promotes. The largest owner of the Company is James Thomas, who controls c 30% of the equity and who founded the predecessor business, Maguire Thomas Properties, together with Robert Maguire in the 80s. The predecessor was split into two companies in 1996 – Thomas Properties and what is now MPG Office Trust. Thomas Properties went public in 2004.
The Company was significantly exposed to looming debt maturities going into the crisis in 2008 and there was significant doubt whether it would be able to successfully refinance its property level debt (there was - and is - no holdco debt apart from a few guarantees on development loans). However, it successfully rolled nearly all of its debt and there are currently no imminent leverage issues at the Company.
The Company’s property portfolio is not over-rented. Many of the properties in the portfolio were acquired as “value-add” prior to the crisis with low in place occupancy. As such, a large share of leases have been signed at more normalized levels. NOI has increased as vacant space is leased, and occupied space is leased at higher rates, either through step-ups included under existing lease contracts or via renewals at higher rates. In 2011, NOI increased c 10% on a comparable property basis.
Shares of Thomas Properties collapsed dramatically from a high of $16/share in late 2007 to a low of under $2/share in the summer of 2009 following the turmoil in the credit markets and the correction in real estate prices. The Company valuation recovered from its lows but reached c $2/share again last autumn during the height of the European crisis. It has since recovered again (current trading at c $4/share); however, it is still quite depressed compared with a sum-of-the-parts valuation analysis of the Company using refreshed valuation assumptions (i.e. c $6/share fair value in our base case analysis).
Exasperated by the low valuation, management published an Excel worksheet to its website to facilitate NAV calculation using investors' own chosen assumptions. We would encourage any interested readers to download it (along with the latest financial supplemental) as a starting point to better understand the NAV.
The Company also took the wise decision to dispose of excess cash via a regular quarterly dividend and it launched a strategy to dispose of fully valued and non-core assets. The intention is to redeploy the cash into higher yielding, core plus and value added situations. The additional operating income will be used to support higher dividends and could ultimately facilitate a conversion to REIT status.
Thus far, the Company has sold four assets for total net cash consideration of c $34m. One additional asset is slated for sale and it is also engaged in various unsolicited discussions for the sale of certain development assets. The Company has c $100m of cash and we anticipate that it will begin to redeploy capital in 2012. The market has begun to revalue the business from the lows of $2/share in the fall to c $4/share current trading; however, we believe there is substantial further upside based on our own valuation work.
We believe Thomas Properties is undervalued because many equity investors largely misunderstand the Company. There is little analyst coverage of the stock and the Company is often mistakenly compared with REITs, which often focus on operating stabilized property portfolios and pay a large share of their income as dividends. Thomas Properties, in contrast, is involved in development and fund management and uses its property income to fund many of these activities. Without a large dividend, the Company is also mistaken as a pure real estate developer. Currently, it is neither a pure core property “dividend play” nor a pure “development story”.
The Company has a current TEV of c $560m comprised of c $200m of market capitalization plus c $460m of operating property level debt less c $100m of cash. NOI is c $45m annualized across the property portfolio. We believe the right way to look at the valuation is using a sum-of-the-parts analysis. On this basis our base case estimate fair value is c $6/share.
The majority of the property value is concentrated in three assets: Commerce Square in Philadelphia (buildings One and Two), City National Plaza in Los Angeles, and Murano condominium inventory in Philadelphia. Collectively these three assets represent $2.50 and $3.00 per share of value. Adding pro-forma net cash of c $2.00/share suggests a valuation of $4.50-$5.00/share covering the current share price. Adding the additional properties in the portfolio ($0.80-1.00/share) and the value of the development assets ($0.30-$0.70/share) gets you to our c $6.00/share base case valuation. We exclude the value of the franchise, but you could add an additional $1.50-$2.00 per share of value by applying a 4-5x multiple to the EBITDA generated from the Company's fund, property management, and development activities. The Company is also engaged in a number of development projects (e.g. the $1bn Wilshire Grand project sponsored by Korean Air) that could generate eight-figure fee income, but we also exclude any value from these activities.
See summary of the SOTP analysis below along with notes on assumptions used per item.
Property Total Value Per Share
Commerce Square (I & II) $75-90m $1.50-1.80
City National Plaza $30-35m $0.60-0.70
Murano $20-25m $0.40-0.50
Pro-forma net cash $100m $2.00
Other Properties $40-50m $0.80-1.00
Development Properties $15-35m $0.30-0.70
NAV $280m-335m $5.60-$6.70
See valuation notes below:
Overall, we believe that the Company equity represents a compelling risk-reward opportunity. The current share price is basically covered by cash and 3 of its 22 properties valued at conservative levels – ignoring the value of the remaining portfolio, its development properties, and the fee generating franchise. Accounting for these other elements in our base case, suggests fair value in the $6/share range (i.e. c 50% upside from current trading).
(1) Acquisition Program. The Company has stated its intention to acquire new properties with the cash on the balance sheet, however, it is hard to imagine any private market real estate transaction that would be cheaper than buying back its own stock. There is execution risk around finding deals at attractive prices as well uncertainty around the length of time it will take to find the deals to sufficiently change the composition of its portfolio.
Mitigant. Thus far the Company has been reluctant to buy back shares for fear that shrinking the already small float will worsen liquidity.
Mitigant. Jim Thomas has extensive real estate experience in the market, a strong track-record, and his incentives are aligned with shareholders given his significant ownership interest in the Company.
Mitigant. Given the depressed valuation, believe attractive returns can be realized even if it takes longer to execute transactions.
(2) Interest rate and cap rate sensitivity. The valuation of real estate is particularly sensitive to interest rates and capitalization rates. Yields on real estate are often compared to alternative yields on other financial instruments. With interest rates at historic lows, there is a risk that cap rates may expand as interest rates rise.
Mitigant. Current cap rates have corrected dramatically from peak levels. Believe those used for valuation purposes are conservative and would withstand gradual increases in interest rates one would expect from a gradual economic recovery.
(3) Liquidity. The Company has a market capitalization of c $200m with trading volume less than $1m per day. This makes the stock susceptible to erratic price movements.
Increased Dividend and REIT Status. The Company plans to redeploy the proceeds from recent asset sales into new core plus and value-added properties. As this strategy is implemented, the Company will increase its distributable cash flow and garner more attention from income-orientated real estate investors typically focused on the REIT space. Management has announced its intention to adopt REIT status in the future as these steps are completed.
Consider the following example to illustrate how this strategy could lead to a re-valuation of the Company: the Company invests $80m of its c $100m of cash into new property at a 7% cap rate, 50% leverage, and 4% cost of debt (these assumptions are in-line with the strategic assumptions conveyed by management on the 4Q11 earnings call). These properties would generate an additional c $11m of NOI and $8m of cash flow per year that would largely be available for distribution under a REIT structure.
Today the Company pays dividends of $3m per year. It can distribute more, but not much more, because its fixed operating costs (due to its small scale) consume much of the available cash flow. As discussed above, we believe the lack of a dividend confuses most real estate investors that are income-orientated. However, following the example above the Company would be able to distribute $11m per year. Dividend yields on office REITS are currently at c 3% - such valuation would suggest a $370m equity valuation or $7.4 per share. In this example, NOI would increase from c $45m to $56m and the pro-forma implied cap rate would be 6.25% or so v 5-6% for publicly traded office REITs.
If instead, the Company were able to find deals at 8% caps then this could lead to an $8.4 per share valuation using the same methodology. In both examples, you’d still have the value of the non-income producing assets such as the Murano condominiums and the developments, which the Company will endeavor to sell in parallel. It is also conceivable that the Company could leverage transactions at greater than 50%.
M&A. James Thomas, the founder, CEO, and largest shareholder of the Company, is in his mid 70s. We believe it is logical for estate planning purposes, for him to seek a merger or sale of substantially all of the Company assets. A sale to a larger publicly traded real-estate business (e.g. Vornado) could offer tax advantages as well as provide liquidity to his estate in a gradual and orderly manner.
Take-Private. There was an unsolicited attempt in the summer of 2010 to take the Company private at $3.75/share led by The Weisman Group; however, the Company board quickly dismissed its proposal outright (there were indications at the time that the board believed fair value to be in excess of $7.00/share). Private real estate investors have speculated that Jim Thomas may sponsor a take-private of the company by himself or with partners given the depressed valuation and costs of operating a public company.
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