NorthStar Realty Europe’s Curious Buyback

NRE logo - CopyIt’s one of the strangest buyback announcements I’ve ever seen. NorthStar Realty Europe (NRE) has authorized the repurchase of $100 million of its common stock. This is tremendously unusual, since companies typically let the market take care of the mispricing of their stock, especially right after a spinoff. Of course, it’s also highly unusual for a REIT to authorize a stock repurchase, but sister REIT NorthStar Realty Finance (NRF) also authorized a buyback, for $500 million. So why the strange step?

From a financial standpoint, the buyback authorization is tremendously smart, if unusual. It takes advantage of the market’s poor reception to the spinoff. As I noted in my prior coverage:

[T]he 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.

At the current price of just $10.44 per share, NRE trades at just 8.7 times this year’s cash available for distribution, or an 11.5% CAD yield. With an estimated 63.7 million shares outstanding, the market cap comes to just $665 million. So a $100 million buyback would be good for 15% of the stock, and it would be accretive to CAD per share and net asset value per share. No execution risk here.

How does this compare to the recently announced buyback for NRF? Well, NRF offers a much better CAD yield than NRE. However, NRE’s discount to net asset value is higher, and my calculations above suggest 88% upside to NAV for NorthStar Realty Europe versus about 57% upside for Northstar Realty Finance. The reason for the discrepancy should be obvious: the European unit was buying properties at a substantially lower cap rate, but European quantitative easing helped boost prices.

What’s it all worth?

Assuming the company completed the buyback today, it would raise NAV per share to $21.21. On a cash flow basis, CAD per share would climb to $1.41, before NorthStar Asset Management took its 15% incentive fee, which it earns on CAD between $1.20 and $1.44 (and 25% of incremental CAD above that). That would ding NRE’s CAD per share by just over three cents.

So on a NAV basis, a buyback looks tremendously interesting, and it’s the type of thing that shareholders should want as well. Given the relatively low cap rates on European trophy properties, it appears that buybacks actually have a higher return on equity than buying new real estate, given the leverage structure planned by the company.

While NRE certainly has the cash to execute the buybacks in full, I wonder if management will execute them. Of course, NorthStar Asset Management is incentivized to do so, given its fee structure, but that doesn’t mean it will. However, management certainly seems to be plowing ahead with buybacks at NorthStar Asset Management, with the recent bridge loan of $100 million, pending the closing of its acquisition of the Townsend Group. Those funds are earmarked for buybacks, according to management on the recent call.

Management has certainly been rattling its sabers about buybacks, and it’s high time they put up or shut up. If we don’t see management create value out of buybacks, the stocks of NorthStar Realty Finance and NorthStar Realty Europe may well continue to linger, even as stupidly cheap as they are. The next few weeks should show how serious management is about creating value.

For all of our coverage on NorthStar, click here.

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