| Highwoods Mulls an MBO |
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Highwoods Properties is considering taking the company private via a management-led buyout. According to Realty Stock Review Online (www.realtystockreview.com), the Highwoods buyout would be financed by Miller Global Properties, a Denver-based firm, the Colorado Public Employees' Retirement Association (Colorado PERA), and a number of private investors. According to Realty Stock Review (Property's sister publication), if Highwoods' management goes ahead with the buyout, shareholders are likely to be offered a price in the range of $25 to $26 per share. In its response to the Realty Stock Review Online report (September 16), Highwoods confirmed "that over the last 18 months it has considered a number of strategic options to increase shareholder value, including business combinations, recapitalizations, and management-led buyouts." Ronald Gibson, the company's president and CEO, added that the discussions are ongoing. Highwoods stated that it does not intend to comment or make any further announcements unless a definitive agreement is reached. Highwoods currently owns or has an interest in 691 office, industrial, retail, and service center properties encompassing approximately 48.6 million square feet, including 45 development projects encompassing approximately 5.5 million square feet, and 2,325 apartment units. Highwoods also controls more than 1,900 acres of development land. Highwoods is based in Raleigh, North Carolina, and its properties and development land are located in Florida, Georgia, Iowa, Kansas, Missouri, North Carolina, South Carolina, Tennessee, and Virginia. The company reported funds from operations of 87 cents per share for the second quarter of 1999, which represented a 10 percent increase over the year-ago period. It was, however, one penny shy of the Street consensus. The one penny shortfall resulted from weaker than expected same-store net operating income growth, as well as the dilutive impact of cash raised from asset sales (more on that later). Highwoods' less than overwhelming 2.6 percent NOI growth in the second quarter was the result of a 70 basis point decline in same-store occupancy as well as a sharp uptick—4.3 percent—in expense growth. Management attributed much of that increase to a substantial increase in real estate taxes. During the second quarter, Highwoods sold nearly all of its assets in South Florida and Baltimore. Those sales netted Highwoods just over $400 million. During its second quarter conference call, Highwoods said that it had another $285 million of properties under sales contracts or letters of intent. If all goes according to plan, the company will sell $700 million to $750 million in properties this year, well in excess of the $250 million to $300 million it estimated at the beginning of the year. Highwoods used part of the proceeds from the South Florida and Baltimore sales to settle its $58 million forward equity contract with UBS. In their report on Highwoods' second quarter results, Merrill Lynch's Eric Hemel and Rahul Bhattacharjee noted that following the sales of the South Florida and Baltimore assets, and assuming that the other properties under either contract or letter of intent at the end of the second quarter close, Highwoods will have funded roughly $550 million of its approximately $650 million development pipeline. As of the end of the second quarter, the Merrill analysts added, Highwoods had preleased 69 percent of the properties it has under development. As we went to press, Highwoods was changing hands at 239/16. Realty Stock Review's recently updated FFO and AFFO (adjusted funds from operations) estimates for this year and next are $3.47 and $2.95 per share, and $3.77 and $3.22 per share, respectively. At an FFO multiple of 6.8x (1999) and 6.3x (2000), Highwoods is attractively valued relative to its peers, the newsletter noted recently. Highwoods' current annualized dividend yield is 9.2 percent. Realty Stock Review also noted that at its current stock price, Highwoods was changing hands at roughly a 25 percent discount to the newsletter's consensus net asset value estimate for the company. |
| Starwood and TriNet Hope To Tie the Knot |
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George Kimeldorf is caught between a rock and a hard place. The president of Dallas-based American National Investors Corp., a privately held real estate firm, Kimeldorf bought 30,000 shares of TriNet Corporate Realty Trust, a San Francisco-based real estate investment trust, for his personal account, thinking he was buying "a long-term bond with an equity kicker." Like other investors in TriNet, Kimeldorf eventually discovered that TriNet wasn't the "steady Eddie" he had assumed. By the time he realized that, TriNet had agreed to be acquired in a stock-for-stock swap by Starwood Financial Trust, a New York-based REIT that specializes in mortgages, mezzanine financing, and to a lesser extent credit tenant lease deals. The dilemma facing Kimeldorf and many other TriNet shareholders is whether to (1) hang on to their shares in the hope that the merger will be vetoed by TriNet shareholders, or (2) if the merger is approved (shareholders will vote on the merger on November 3), wait to see how the post-merger entity fares, or (3) sell before the vote. Kimeldorf, like other TriNet shareholders he has spoken to or corresponded with, believes he would be better off if the merger is voted down. Kimeldorf is so convinced that the merger is a bad idea that he put up his own money to mail a letter to TriNet shareholders. "Since this merger requires a two-thirds vote for passage, I feel we can successfully protect our investment by defeating this proposal," he wrote. In a recent interview, Kimeldorf said he had heard from a number of investors who agreed with his analysis of the deal. However, he conceded, the number of investors he heard from was small. Kimeldorf added that he had hoped his letter would serve as a rallying cry for other individual investors. That didn't happen, he said. To understand what has Kimeldorf so upset, you have to go back to TriNet's beginnings. The company came public on May 25, 1993, at $241/4. Sold to the public as a conservatively structured REIT that would specialize in so-called triple-net-lease deals, TriNet's management was continuing a business it had been in for some time as a private company. (Boiled down to its essence, a triple-net-lease deal is one in which the tenant signs a long-term lease, often 20 years with several renewal options, and agrees to assume all costs associated with its tenancy.) What makes the conventional triple-net-lease transaction so attractive is that the tenant has to pay rent come hell or high water. If you're dealing with a so-called credit tenant—ideally a company with an excellent credit rating—the risk of default is virtually nil. The tradeoff, of course, is that unlike the conventional commercial real estate transaction, there isn't much potential for growth. Hence, the long-term bond with equity kicker analogy. In recent years, TriNet's management veered off course, however. Whereas the typical net-lease deal is a single-tenant property, one that is perhaps being used as a corporate headquarters or a distribution facility, TriNet began to do multitenant deals. It also entered into joint venture development deals. Whatever the merits of those transactions on their own, they certainly weren't the type of deals that Kimeldorf and other shareholders thought the company would be doing. Though TriNet disclosed what it was doing, many shareholders didn't recognize that slowly and inexorably, TriNet's management was taking on added risk in the hope of delivering higher returns. TriNet's problems didn't end there, however. In a recent report on the company, the Penobscot Group, a Boston-based buy-side research boutique specializing in REITs and other property-linked stocks, pointed out not only that many of TriNet's leases weren't conventional triple-net leases (the lease durations being more in line with the seven- to 10-year leases commonplace in conventional commercial real estate deals), but also that rather than arising out of long-standing relationships with corporations, TriNet's deals frequently were one-off transactions that came in over the transom from commercial real estate brokers. As a result, according to Penobscot's Fred Carr, the creditworthiness of TriNet's tenants wasn't in line with the low-risk strategy inherent in the conventional credit tenant lease business. TriNet's board tried to right the ship, dismissing the company's CEO at the time and vowing to mend its ways. Unfortunately for the company and its shareholders, by then it was too late. Not only had the marketplace begun to question TriNet's ability to do the sort of deals that had been its mission in the first place, but the REIT market by then was experiencing rough sailing. After several false starts, TriNet's new management team, led by Rob Holman, the company's chairman and one of its founders, and the TriNet board concluded that the best course of action was to explore other options, including a merger or an outright sale of the company or its assets. The proposed merger with Starwood, a high-flying REIT founded by Barry Sternlicht, Jay Sugarman, and a handful of others (Sternlicht is the chairman and CEO of Starwood Hotels & Resorts Worldwide), was announced in mid-June. To characterize the reaction to the merger as being less than enthusiastic would be a major understatement. The initial reaction was so negative, in fact, that Starwood and TriNet's managements took the unusual step of hosting a second conference call to review the merger with sell-side analysts only. Among the objections to the merger were that the investment objectives of the new company would be far different and, in the view of the analysts, more risky than the objectives set forth in TriNet's original business plan. Another sticking point was the fact that key members of Starwood's management, including Sternlicht and Sugarman, would be selling the company that advised Starwood Financial to the merged entity. According to industry veterans, Starwood Financial's management initially proposed that they would receive 5 million shares of stock in the new entity in exchange for the advisor. When Starwood Financial's shareholders (those shareholders were rolled into the REIT in exchange for their interests in several opportunity funds organized by a private entity founded by Sternlicht) balked at that deal, Sternlicht, Sugarman, and the two other executives who stood to benefit from the deal altered their proposal. The Starwood execs would receive 4 million shares of the new entity's stock in exchange for the advisor, and 1 million shares would be distributed to shareholders in Starwood Financial premerger. In a note to his firm's clients, Larry Raiman, who oversees the REIT research effort at Donaldson, Lufkin & Jenrette, wrote "We perceive this transaction to contain a conflict of interest in that Starwood Financial is monetizing the value of its related-party advisor by issuing 4 million shares of common stock. Starwood Financial is also issuing its current shareholders a stock dividend totaling 1 million shares. Each of these items are dilutive to TriNet shareholders." In a recent interview, Raiman underscored his concerns about the structure of the transaction as well as his concern that the merged entity, regardless of the merits of its business plan, is a good deal riskier than TriNet shareholders may be prepared for. "Starwood is talking about leverage in the range of 1.5 to 2-to-1. That may not be high leverage to some investors, but it's a good deal more than the TriNet shareholder who bought the stock as a bond equivalent may have bargained for." Equally troubling for some analysts and individual investors, such as Kimeldorf, is the issue of exactly what TriNet shareholders would receive after a merger. The terms of the merger call for TriNet shareholders to receive 1.15 shares of Starwood Financial for each share of TriNet they own. Getting a handle on valuation in a stock-for-stock deal is always tricky, but in this case it's nearly impossible. The problem stems from the fact that not only is Starwood Financial a closely held vehicle (99 percent of the stock is held by insiders and investors in the Starwood partnerships who have pledged not to sell their shares), but also a number of analysts and investors disagree with Starwood's management about where the stock would trade post merger. David Sherman, who oversees the REIT research effort at Salomon Smith Barney, says he likes the post-merger business model a lot better than the "old TriNet" model. He recently wrote in a research note that there are really no comparable companies to look at for clear guidance. Valuing the post-merger entity, he added, "is harder than for any other REIT we follow." In the near term, Sherman and others don't see much upside in the stock if the merger is approved, and they acknowledge there could be some downside as TriNet shareholders sell their stock. Longer term, Sherman says the new Starwood might see a multiple expansion, but that won't happen overnight. Kimeldorf says he wishes there was an option other than the merger. He would have preferred an outright sale of the company. And, in fact, there were several bidders who offered an all-cash deal. TriNet and its financial advisor, Greenhill & Co., a New York investment bank, disclose in the proxy statement that there were a number of cash bids, but none was viewed as being superior to what Starwood was offering. Perhaps that's true, but industry veterans contend the $27.50 all-cash bid from a fund sponsored by Morgan Stanley would have been a better option. Sources close to TriNet and Greenhill believe that with the benefit of hindsight, some people may say that's the case, but had TriNet's board accepted an all-cash bid roughly equal to the price TriNet was changing hands at the time, TriNet's board and management would have been boiled in oil. "If you think investors don't like this deal, they would have screamed if TriNet had sold out for that much under the REIT's net asset value, estimated in the range of $30 to $32 per share," said one source. If TriNet were offered for sale today, he suggests, the offers would be in the low $20s at best. DLJ's Raiman is not so sure that would have been the case. He points out, for instance, that there would have been significant costs associated with converting TriNet into a private entity, including prepayment penalties on debt. If the details were laid out for shareholders, they would have understood the options, and if they didn't like the terms, they could have voted the deal down, Raiman said. If shareholders veto the Starwood merger, TriNet management has to come to grips with running the company or selling to someone else. However, if TriNet does a deal with someone else within nine months of the merger being vetoed, it will have to pay Starwood a $50 million (roughly $2 per share) break-up fee. The combination of the break-up fee and the fact that there are no caps or collars on the deal troubles Raiman and others, including the Penobscot Group's Carr. Others say that TriNet was out of maneuvering room. The company had to do something, and if shareholders don't like the Starwood deal they can either vote against it or vote for it and wait until the 5 million share buyback that has been promised kicks in," said one source close to Starwood. He reckons that the road show management is doing to drum up interest in the company post-merger will drive buy-side interest in the stock. Further, he says that once the company moves to the Big Board following the merger and the buyback goes into effect, shareholders will get a better price than if they try to bail out immediately after the deal starts trading. |
| Stock Buybacks |
| Reckson Steps Up to the Plate |
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Reckson plans to use a portion of the $470 million it received from the sale of noncore assets to fund the buyback. Reckson will purchase the shares in open-market or in privately negotiated transactions. In a recent report, Eric Hemel and his colleagues at Merrill Lynch & Co. pointed out that based on any one of several valuation metrics (see table above), Reckson is one of the cheapest office/industrial REITs in its primary coverage universe. For instance, in mid-October, the Merrill analysts estimated that Reckson was trading at roughly 70 percent of their estimate of the company's net asset value. Given Reckson's attractive valuation, Hemel and other analysts, including Kevin Comer and his colleagues at Deutsche Banc Alex. Brown, are asking whether investors should be buying Reckson's class A or class B shares. Both Hemel's group and Comer's concluded the class B shares (for now) look more attractive. According to the Merrill analysts, the incremental dividends paid to the class B holders over the next 4 1/4 years will be $3.21. After discounting these incremental dividends at 8.2 percent, which is equal to 5-year Treasurys plus Reckson's credit spread of 230 basis points, the incremental net present value is $2.62. "When we add the $2.62 to Reckson's class A share price, we derive a ‘fair value' for the class B shares of $21.12, which is almost 5 percent above the [then] current price of $20.13 (see table above). Therefore, for investors where liquidity is not an issue, the class B shares offer slightly more value than the A shares," Hemel and his colleagues concluded.
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Reckson's Class B Shares When Reckson acquired Tower Realty earlier this year, shareholders in Tower received class B shares of Reckson as part of the deal. The class B shares automatically convert into class A shares on a one-for-one basis beginning 41/2 years from when they were issued. They are virtually identical in every respect to Reckson's class A shares except, as Merrill Lynch's Eric Hemel points out, the B shares currently pay a significantly higher dividend. In addition, the class B shares are not entitled to capital gains distributions that Reckson may make over the 41/2-year period as a result of property sales. Looking ahead, Hemel and his colleagues pointed out, the dividends on the class B shares increase—in the second quarter of each year—at a rate equal to 70 percent of the growth in Reckson's FFO per share for the prior 12-month period. In contrast, Reckson's class A dividends will probably increase at a rate similar to its FFO per share growth for the foreseeable future given that the company has reached the minimum payout ratio as per the REIT rules. As an aside, Reckson has historically raised the dividend on its class A shares during the second quarter of each fiscal year (the quarter ending June 30). |