NorthStar Realty Finance (NRF), NorthStar Asset Management (NSAM), and Colony Capital (CLNY) finally agreed to the tie-up that they had pre-announced a few weeks ago. The move cures a number of problems at the troubled NorthStar businesses, the most important of which is the company’s own management, who are largely ousted as part of the merger of the three real estate companies. But management will have their pound of flesh before they exit, including a huge takeover premium for insiders. Yep, the same management who helped create this mess takes home another huge payday.
Nevertheless, the pro forma company is being valued at a modest 7.5x FFO, will pay out a well covered dividend, and it should be able to grow. That’s too cheap.
The devil in the NorthStar details
The combination of the three companies actually makes some sense, even though holders of NorthStar Realty Finance are being fleeced. The deal eliminates the external management structure that is so loathed by Wall Street and expands the “go anywhere” expertise of the companies. Plus, the company has a reasonable leverage ratio and starts life with nearly $1.3 billion in liquidity (mostly cash), which should allow it to grow. Finally, NorthStar management will ultimately depart, capping more than a year of disastrous performance for their stocks. This investor presentation provides the details on the transaction. The new company will be called Colony NorthStar and will be run by the managers at Colony Capital, which has a long history under Chairman Tom Barrack.
To effect the deal, holders of NRF receive 33.9% of the new company, while CLNY holders and NSAM holders receive 33.25% and 32.85%, respectively. Colony NorthStar should have about 600 million shares and generate FFO of $1.55-$1.75 in 2017. It should pay out about $1.08 per share, or a 9% forward yield on the various stock prices today. The math works out to the companies trading at 7.5x future FFO. Very cheap.
But here’s how NorthStar Realty Finance shareholders got fleeced. The deal was structured so that the companies combined at their respective market valuations. NRF had been trading at less than half of the most recent calculation of its net asset value of $26 per share and not far gone from a $29 valuation in November. NRF is much more relatively undervalued than the other two partners, yet it received almost the same stake in the new business. So as part of the deal, NRF has much less upside than it otherwise would have had.
And that $1.3 billion in liquidity at the new company? Most of that comes from the liquidation of the NRF portfolio. Instead of being used for stock repurchases at huge discounts to NAV, it will be used to fund growth at Colony NorthStar. At the same time, NRF owners will lose 25% of their future dividend, going from $1.60 per share to around $1.20. However, if the company had repurchased stock, as management promised, there would be no reason to cut that dividend, and it could even have been increased. Instead, the NRF dividend cut actually funds a dividend increase at NSAM, with CLNY owners maintaining their payout post-merger. That’s how NRF owners got jobbed out of their payout.
One last poke in the eye
On the way out the door management clipped shareholders for a lot more cash. They’ll be taking a payday of 1.8% of Colony NorthStar stock, valued near $180 million. Although the shares do not vest for a year or two following the completion of the merger, it’s a short period and NorthStar managers are not likely to stick around too long afterwards. It seems somehow fitting to pay management even more to extricate shareholders from the value-destroying mess for which they were already paid well.
That’s some gall. But don’t let the door hit you on the way out.
Nonetheless, this deal should change the market’s sentiment surrounding the NorthStar companies, with the elimination of management being a key factor in the market’s re-assessment of the stocks. At a modest price to cash flow, the stock of NorthStar Realty Finance should trade higher, and I think upside of 50% higher is in play.
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