Is This REIT Stuck Between a Rock and a Hard Place?
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CommonWealth REIT (NYSE: CWH), a real estate investment trust that owns office buildings throughout the United States, is in the midst of a heated battle between an entrenched management and an activist investor group. The group, led by hedge fund Corvex Management and Related Fund Management (Corvex/Related), hopes to better realize the company's intrinsic value by ousting its board and then management.
Shareholders have a tough choice to make. They can either stick with the current operations team whose tenure has coincided with the REIT being one of the worst performers in the industry, or bet on relatively unknown financial operators who promise to shake things up. Investors seem to be stuck between a rock and a hard place.
A rock: management’s view
CommonWealth's management is clearly not going away easily. They have waged a full-scale offensive to keep their positions at the company. It's easy to see why.
Officially, the REIT has no employees; a company called Reit Management & Research (RMR) runs its entire operation. RMR provides all management and administrative services for cash compensation. This firm has little ownership in CommonWealth -- less than 0.5% mostly from grants -- so it stands to lose a significant source of revenue that may be difficult or even impossible to replace if forced out.
Management's case for maintaining the status quo includes the assertion that Corvex/Related's real plan is to seize control at a bargain price and realize a quick profit. RMR has also defended its performance by demonstrating the progress of its business plan, focusing on high quality, central-business-district (CBD) office properties and divesting suburban office and industrial properties. RMR notes that since 2007, CommonWealth has increased its portfolio of CBD office properties by $3.7 billion while selling $1.5 billion of suburban office properties for significant gains.
A hard place: the activist's view
Corvex/Related's case for change is pretty straightforward. The group believes that CommonWealth is undervalued by the stock market because of mismanagement and a misalignment of incentives between shareholders and RMR.
The activist investors note that recent actions by management, including a highly dilutive equity offering and repeated efforts to eliminate investors' rights, demonstrate a lack of responsibility to shareholders. They insist that RMR is operating CommonWealth mainly for its own benefit and believe that the company's true value will never be realized as long as the current board, whose independent allegiance to shareholders has been questioned, and RMR are in place.
I've owned CommonWealth on and off (mostly on) for many years, and shares have consistently traded well below their calculated intrinsic value during that time. This was especially frustrating when the same valuation method has reaped comfortable gains with similar REIT’s.
So, it's hard to dispute that the management structure depresses the stock price, but it also seems RMR has done a decent job of managing the company so far. While most REIT's suffered after the 2008 financial crisis, and some continue to struggle, the company has come through reasonably well. CommonWealth’s current stock-market discount and its resilience from the financial crisis can be seen via a comparison with some peers.
CommonWealth’s valuation and comparisons
In 2008, CommonWealth reported revenue of $752.1 million and cash earnings of around $104.7 million with an earnings profit margin of 13.9%. Based on a cash earnings times a market capitalization multiplier calculation, the company's fair business value was $26 to $27 per share at that time using a standard 16x multiple.
In 2012, the company ended up posting revenue of $1 billion and cash earnings of $150.6 million, or a margin of 14.9%, maintaining its fair value of around $26 to $27 per share post crisis - much higher than its stock-market value.
Mack-Cali Realty (NYSE: CLI) is a fellow REIT that owns a portfolio comprised predominantly of Class A office and office/flex properties. While its current share price more closely resembles its intrinsic value, Mack-Cali has not recovered from the crisis as well as CommonWealth.
In 2008, the company had revenue of $773 million and cash earnings of around $157 million with an profit margin of 20.3%, resulting in a reasonable business value of around $31 a share at a 16x multiple.
In 2012, the company posted revenue of $705 million and cash earnings of $148 million at a margin of 21%, producing a fair value closer to $23 to $24 per share. In an attempt to recover its value, Mack-Cali has started to diversify into residential properties and in October 2012, the company acquired Roseland Partners, a premier multi-family developer and operator for around $134 million.
Brandywine Realty Trust (NYSE: BDN) is another REIT peer with a portfolio of office, mixed-use and industrial properties. While its share price more closely resembles the market premium currently given REIT’s, it too has not recovered its pre-financial crisis value.
In 2008, Brandywine posted revenue of $581 million and earnings of around $101 million at a profit margin of 17.4% with a fair value around $18 per share at the standard multiple. The company booked revenue of $560 million last year with cash earnings of around $96 million at a margin of 17.1% providing a fair value closer to $11 per share.
Like Mack-Cali, Brandywine is also diversifying into the residential market to boost returns. It is developing a 33-story student-housing tower in Philadelphia and is in a multi-family 50/50 joint venture with home builder Toll Brothers.
The battle over CommonWealth is going to be fierce. While both sides agree that that the company has been little appreciated on Wall Street, they differ on who can change that circumstance. Shareholders must choose either a historically unsuccessful entrenched management or a relatively unknown financial player with an untested plan. Who can blame them for feeling that they are between a rock and a hard place?
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