Description

I believe Colony Capital preferred stock represents a safe current yield in the mid-high-8%s with a reasonable probability the securities are called at par over the next year which is ~1% premium to current prices. Thus, I see a total return potential close to ~10% over the next year with little risk of value impairment.

Colony Capital (CLNY) is a leading global investment management company that focuses on investing in real estate and currently manages $44bn of assets. In early 2017, CLNY merged with NorthStar Asset Management and NRF to create larger, more diversified internally-managed equity REIT. Unfortunately, this merger was poorly timed and executed from CLNY’s perspective and operating challenges led CLNY to cut the dividend by 60% in February 2018, which has led to a >50% decline in CLNY common stock.

CLNY founder Tom Barrack owns 28.5 common shares worth approximately $175 million. On the March 1, 2017 conference call (where they announced the dividend cut), Barrack said “I am 100% focused. I am still one of the largest personal shareholders in this company, it’s the majority of my personal net worth, it’s the dominant factor in my and my family’s pride, reputation and future, and I don’t intend to leave it tainted or unattended.” As another validation of the value of CLNY, it’s notable that Baupost Group owns ~10% of the outstanding common stock.

Barrack had stepped down from the CEO role in 2014 (he remained Chairman) but retook the CEO role last month. With Barrack back at the helm, I believe the company is now focused on turning around the company by 1) selling non-strategic assets, 2) growing its third-party asset management business and 3) reducing balance sheet leverage. Evidence of this greater focus can be seen through faster pace of execution on non-core asset sales and an announced $50-55m of G&A cuts (mostly due to business lines CLNY is exiting). CLNY currently has $1.5bn of non-strategic investments it is in process of selling and has committed to selling $1bn by end of 2019. These sale proceeds will be partly re-invested into new investments (particularly GP stakes in new investment management fund raisings), but I believe a portion of the proceeds will also be used to reduce leverage.

Based on my NAV analysis (see below), CLNY common stock is currently trading at a 23% discount to NAV and pays a 7.1% dividend yield. However, I believe CLNY’s preferred stock represents a safer risk-reward profile. CLNY has $1.4bn of cumulative redeemable preferred stock (see below). These are 6 separate issues that are all pari passu. This preferred stock sits at a 57% - 68% loan-to-value ratio, and has common stock market capitalization of $3.2n beneath it. In Q2 CLNY redeemed $200m of its Series D preferred which carried an 8.5% coupon. Given the high coupon rates and ability to call at par, I believe it makes sense for CLNY to continue to reduce its outstanding preferred stock as they sell non-core assets. Specifically, I believe CLNY may choose to redeem either its Series B preferred stock (8.25% coupon, currently redeemable) or Series E preferred stock (8.75% coupon, redeemable May 2019). Both the Series B and E preferred stocks are currently trading slightly below par and have current yields of 8.4% and 8.8%, respectively. I think there is a reasonable probability that either Series B or E preferred stock issuances are redeemed at par (~1% premium), leading to a close to ~10% total return over the next year. Even if these issuances are not redeemed, I believe the current yields are attractive relative to margin of safety they possess.

Exhibit 1: NAV analysis

Exhibit 2: Preferred Stock Issuances Oustanding

Catalyst

Sale of non-core assets should improve credit profile of preferreds and potentially lead to call at par.