Description

CommonWealth REIT is one of the few “externally managed” REITS.  The founding family (run by father and son team Barry and Adam Portnoy) owns less than 0.3% of the shares, yet owns 100% of the REIT’s management company (RMR) which has been collecting a juicy fee equal to 3% of gross revenues plus all sorts of extra fees.  For years the founding family has been milking the REIT for fees while shareholders suffered.  In 2013, Corvex Capital Management (run by Keith Meister who used to work for Carl Icahn) and Related (Jeff Blau) used a provision in the company’s charter to try to remove the whole board.  The company fought back and the situation ended up in court for over a year.  However, in 2014, on March 25^th the activists successfully removed the entire board with support from 81% of the shares.  A special meeting to elect the new board will be held on May 23^rd.  The activists are the only people who have put up a slate and theirs includes Sam Zell (a renowned office real estate investor you may have heard of) as chairman and David Helfand (former CIO of Zell’s Equity Office Properties) as president.  Essentially, I believe CommonWealth is about to replace value destroying management with a team that can successfully grow the business and generate returns for shareholders.  The net asset value of CWH is around $30-$35 today and we agree with the activists that the value could be $40+ in a year or two under Zell’s tutelage.  Meanwhile, we should be picking off a dividend that only increases from its recent $0.25/qtr rate as the portfolio improves and some of the excess RMR cost is removed.

                Corvex and Related have done an excellent job laying out the investment case here in multiple decks over the course of their year-long battle to remove the Portnoys.  I refer you to:

http://www.shareholdersforcommonwealth.com/wp-content/uploads/2014/03/A-New-Beginning-.pdf

This gives a good overview of Zell’s record of success and the value destruction by the Portnoys.

http://www.shareholdersforcommonwealth.com/wp-content/uploads/2014/02/Consent-Solicitation-II.pdf

This one makes many of the same points as the above presentation, but shows the property valuation by the activists from page 67.

The complete timeline of the battle for control is available here:

http://www.shareholdersforcommonwealth.com/timeline-2/

The complete slate of new directors and their backgrounds is available here:

http://www.shareholdersforcommonwealth.com/nominees/

To update the valuation math here to account for recent Q, dilution from Series D preferred conversion, etc:

Properties:  ~$6,950 +/- (from activist valuation deck see page 71)

Cash:  $177 million

Rents Receivable: $239 million

22 mil shares of SIR: $628 million (NB: Portnoys just issued 9 million shares at $29 to dilute CWH on May 14^th – I’m not sure this is going to work for them given how badly they got beaten at CWH.  CWH’s stake after the dilution is 37%.  However, it does appear like they are going to put up a fight to retain management of SIR assets).

Total Assets:  $7,994 million  (excludes $206 mil in other assets)

Less Total Liabilities: -$3,241 million

Less Pref Series D 6.5% (portion not converted): -$116

Less Pref Series E 7.25%: -$275

Remaining Value to Equity: $4,362

Shares Out (post Series D conversion): 128.8 mil shares

~$33.86 per share

So at $25.14 we feel like we are buying at a decent discount to NAV.  In addition I think Zell’s plan is to “do another EOP” as this clip suggests:  http://video.cnbc.com/gallery/?video=3000249372)

Risks:

• Presumably Zell and Helfand are going to be buying shares in CWH: How many will they buy?  How many will be granted?  How dilutive will it be?  I am sure Corvex and Related don’t want to get hosed here, but Zell knows how to get a good deal for himself so it merits watching.
• The properties are generally so-so assets in so-so markets.  The bulk of the value is in Chicago, Philadelphia, Austin, Indianapolis, and Denver.  The complete list of assets is here: http://www.cwhreit.com/locations/view.aspx
• Obviously, this is an interest rate and office property market sensitive position.  Generally, my sense is that the office market is a little behind the recovery in the residential market, so there should be room for some improvement.
• The Portnoy’s are not giving up at SIR.  They just issued 9 million shares last week so I presume they are ready to battle for control with Zell and Helfand.  SIR was previously written-up on VIC by jwilliam903 and fizz808.

Hat tip to abra399 for an excellent write up of the series D preferreds and a trade which worked out well.  With the common stock trading at $25.14, I think there is substantial upside here and good margin of safety.  It’s not $15 like when the activists first got involved, but it is not near fair value yet either and much of the risk has come out of the story.  Zell and Helfand should run a value creating strategy from here starting on May 24^th.  In a world where value is scarce, I like the odds at CWH from here.  Sorry this is not the world’s most creative idea, but I’m struggling to find great values this year as I am sure many of you are.    

Catalyst