NorthStar Realty Europe — The Little Spinoff That Couldn’t

NRF imageWhat does the NorthStar complex have to do to get some love from the market? NorthStar Realty Finance (NRF) just spun off NorthStar Realty Europe (NRE) earlier this week, and the stock got beat with the ugly stick. NRE owns high-quality real estate in major European metros (Hamburg, London, Paris, Frankfurt, Berlin, Milan, and others). While it’s expected that externally managed REITs should be discounted, the discount being applied to NorthStar Europe is striking. Does the market hate external manager NorthStar Asset Management (NSAM) that much? Or is something else going on?

Given the potentially taxable nature of the transaction – NorthStar Europe was treated like a taxable dividend – it might not be surprising if some investors wanted to sit this one out and wait for the stock to trade publicly before maybe taking a dip. But the debut certainly fell short of management’s publicly communicated expectations of 20x+ multiples to FFO (a price of $24+), what European-listed peers are fetching. NRE now trades at less than 10x and pays a 5.3% yield, a real bargain basement. That multiple is still high enough for management to issue equity and make some deals, given Europe’s very low interest rates and the still-high spreads.

But look at it on an asset basis. Book value – on properties very recently acquired – comes to $887.1 million, or $13.92 per share, according to p.79 of the NRE prospectus (linked here). NRE’s market cap comes to $716 million. So the stock’s priced at 80% of tangible book value, to start. But wait…

The NRE investor presentation presents a different picture. As noted on p.8 there (linked here), equity comes to $1,338 million, not counting a $340 million convertible and $250 million in cash, or a net -$90 million. So on that basis, book value comes to $1,248 million, or $19.59 per share. Were assets marked up in a fair value adjustment as part of the spinoff? If not, then there’s still more upside.

Even if assets weren’t marked up, then this is a huge disparity. NSAM management has consistently reiterated that the properties have appreciated in value, and they’re selling a few of the smaller parcels for 40% above their purchase price. And there’s some indication that the prior owner of the SEB portfolio was a non-economic seller, so maybe they got a better price than otherwise there.

Now, you can believe management or not that properties have appreciated, but why would you own the stock if you think they’re poor investors? That’s like going to a concert to boo. Their track record suggests otherwise, too. So why is NRE trading at a significant (or massive, depending on your source) discount? Concerns over forex? Concerns over management? Concerns over management’s conflicts of interest?

It may well be the last, given NRF’s steep decline following the announcement of NRF’s dilutive acquisition of European properties in May. What do you think? Is NRE the value it seems?

For all of our coverage on NorthStar, click here.

8 thoughts on “NorthStar Realty Europe — The Little Spinoff That Couldn’t

  1. Other than factual statements, the following is just my opinion.

    First, imo, the institutional market has been voting with their feet since the Monday following the Friday night filing of proxy statements disclosing obscenely excessive compensation.
    The shareholder vote on that compensation was on Wednesday, 5/27 but NRF did not disclose the results until after the close on Friday, 5/29 (a sneaky, underhanded move, imo).
    The selloff accelerated the Monday following disclosure of the compensation vote results.
    This management withdrew forward guidance for NRF. This management now allows only one hour between releasing two sets of financial statements and the beginning of the conference calls, down from two hours, which is not enough for analysts to prepare questions based on number-crunching.

    In short, I believe the tutes have lost trust in this management.

    In addition, in my opinion, this management did an extremely poor job of communicating the per share values to the public. Not once, to my knowledge, did they disclose contributed equity of 19.59 per share or fully depreciated book value of 13.75 per share (876 million at 6/30 adjusted / 63.7 million shares).

    Furthermore, the presentation materials cite Green Street Advisor’s data on UK and ex-UK European REIT multiples as support for their multiples. How many of those REITS trade only in the United States? How many are externally managed? How many are both? One has to question whether the “comparables” used are really valid comparables. Should this be listed in Frankfurt with ADRs trading in the US? I think yes. You want European multiples then trade in Europe.

    The “announcement” of the post-spin expected dividend policy was not an announcement at all. It was a bullet point in presentation slides attached as an exhibit to an 8-K filed with the SEC. No press release. Do they expect the entire stock market to read every exhibit attached to every SEC filing? It is no wonder (to me) the market did not appear to understand go-forward dividend expectations.

    Next, the market was told the spinoff of NRE was a fully taxable transaction, but NRF has not to date released any tax guidance. They have not announced the value ascribed per share to NRE, nor have they given any guidance on the percentage, if any, of the 2015 distributions will be treated as return of capital for tax purposes. In such a case, a prudent taxpayer must assume 100% nonqualified dividend. I think much of the NRE selling is to convert paper taxable income to cash. Another communication failure.

    Last, I think a 1 for 6 spin ratio followed by a 1 for 2 reverse split just confused the market while the when-issued was trading. When in doubt, sell.

    Those are my conclusions on why NRE is currently grossly undervalued. It is also why I bought some when-issued to add to those I received in the spinoff. It will take time, but I think eventually the market will understand the value of NRE.

  2. Dan, certainly management has been less forthcoming on the business since the NRF/NSAM split. While they used to give guidance in the pre-split days, that’s all been dropped, except in ways that are less obvious, as you note. An investor could certainly find the NRE/NRF dividend information before NRF sent out a PR about it, but management didn’t make it so easy to find. My question: why is that? The hedgies are going to find the info; no one’s hiding it from them, bur retail investors are another matter. You have to lead them right to the water and then put their nose in it, and even then you have to hope they figure out what’s going on. Hamamoto et al (pun intended) are savvy guys and they understand how the markets work, so a change in their behavior should indicate something to us. As you note, some of that change has come in how their communication regarding earnings, comp, etc. But I think there’s more than that.

    I’m not convinced the decline in NRF is due mostly to their pay packages, excessive though they are. A number of factors are also at play: potential for higher interest rates, NRF’s exposure via floating rate financing, overlevered and weakhanded hedge funds facing redemptions, the spin of NRE that makes NRF’s payout ratio go up even more, imperiling the dividend, the vicious circle of investors fearing a double-digit yield and thinking other investors know something, etc. Declines beget more declines until someone steps in or the market comes to its senses. But I think the real killer, and it’s the concern at all externally managed REITs, is the conflict of interest: the desire of the asset manager to grow at any cost versus the desire for accretive growth at the REIT level. We know how that usually works out.

    I’m pleased to see their buyback announcement but am curious whether they actually take advantage of it. At a 15% RoE and very low execution risk, I hope they do, but I have not run the numbers on how that move advantages (or not) NSAM. It should move them into the high splits and then they collect the base management fee regardless, so no skin off their back that way. That would help shore up the dividend, and make NRF more attractive, but again there are those conflicts of interest. NSAM is going to have to show that they treat NRF right, and good communication is clearly part of that. That said, if they do and the market continues to misprice NRF, I’m all for taking advantage.

    Thanks for your comment.

  3. Most of the interest rate risk is in the hotels where they have the ability to raise rents rapidly if competitive conditions let them. The competitors are in the same boat to the extent of floating rate debt, so the competitive environment is neutral to raising rates to that extent.

    You don’t think compensation and distrust of management is the cause? Chart NRF vs VNQ from the Friday of the proxy statements and then the Friday of 5/29. What do you suppose the selloff was on Sep 25, 28 and 29 on 42 million of volume knocking the price down nearly 14% but tutes doing reverse window dressing so they would not have to disclose owning NRF on 9/30?

    Then you get Tylis at presentations sounding like the pot calling the kettle black when talking about about how bad other external managers were when NSAM was so good. It was like Ted Bundy calling Charles Manson a really, really bad man. Tylis the buffoon. Didn’t his mother teach him you never build yourself up by knocking somebody else down? Then comes wonder boy Langer, sounding like a freshman in high school about to flunk out….you know, uh, er, you know ahh, you know. A 2 million signing bonus and he sounds like a dope (to me).

    IMO, the problem is a “stink” attached to management as excessively greedy, untrustworthy and with Langer and Tylis, incompetent. The only reason there was not a huge tute net sell in 2Q was Vanguard bought over 22 million shares for NRF’s inclusion in the RMZ on 5/29 when 2Q saw the float increase by 69 million shares. Look at the tute changes when all the 9/30 reports are in. I think it will show a huge net sell.

    I agree, the deck is stacked in favor of NSAM. That’s because the big shot insiders knew they would own a much bigger percentage of NSAM than they would of NRF or NRE. When the NSAM spin happened, everybody was equal. A dollar out of the left pocket (NRF) = a dollar into the right pocket (NSAM). Now with the big shots owning a much bigger percentage of NSAM than NRF (or NRE), something like, (as illustration only,) 70 cents comes out of the big shots left pocket so 1.00 goes into the right pocket. With this situation, why has NSAM not skyrocked? IMO, the stink of management.

    I have been in the stock market for over 30 years and have never seen such a dismal rollout of a spinoff as NRE. It has to be something. IMO, it’s nonexistent communication on top of mistrusted management. Despite this, I believe the fundamentals of all Northstar companies are sound and are currently underpriced. Why? the only reason I can think of is the stink of a greedy, mistrusted management.

    1. Sorry, your comment got captured by the spam filter, no idea why.

      Management projected NOI for 2015 of $135 mn in the investor presentation, which you can find linked under Recent Spinoffs. I’ve got no reason to doubt what they’re projecting.

  4. What number do you see for EV of the business? I cant seem to find an accurate number since there seems to some conflicting numbers. Thanks!

    1. I see $1.4 bn in mortgage notes, $340 mn in stock-settable notes, and $250 mn in cash. So that’s net debt of $1.5 bn. Add that to market cap of $592 mn, and you get an EV of nearly $2.1 bn. However, one should probably also include $118 mn in portfolio-level preferred equity in there as well, so about $2.2 bn.

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