Description

Remarkably, Merchants National Properties has never been written up on VIC.  No doubt it’s small and illiquid and really only suitable for small funds or personal accounts, but it has a long-standing value pedigree and – while it may not have the catalyst or pizazz of some submissions - I dare argue that by submitting Merchants I correct a rather glaring VIC omission. After all, how often are you able to own a share that may once have been owned by both Messrs Buffet and Schloss?

Merchants was incorporated in December 1928 with 17 properties costing approximately $3.5m. A lot has changed since then, but it’s still mostly a NYC real estate play with an attendant property management arm that is finally being run for the benefit of Merchants (more on this later). Additionally, the company owns a fairly large securities portfolio – $65m – equating to approximately $708/share (albeit with a de minimis tax basis). Book value is $2,261/share.

While the company today owns interests in some 40-odd properties, most notably are the below:

·       A 37.6214% interest in the Cross Country Center ‘CCC’ (https://www.crosscountycenter.com/), a 1,073k sf remarkably successful shopping complex located in Yonkers NY. CCC once had the most successful Sears in the USA, but those days are no longer.  Happily, however, they’ve had little trouble backfilling the space – mostly to Target – and the shopping center as a whole rarely has vacancies.

·       A 35.7135% interest in 10 Grand Central (http://10grandcentral.com/), a 432k sf 35-story office building, which the company recently did an excellent job of repositioning. They’ve recently recaptured two of the buildings lower floors which had been rented out at about $35psf and expect to release them and about $65psf. I understand some of the higher floors rent for substantially more.

·        An 23.33% interest in 545 Madison (https://www.545madisonnyc.com/), a 140k sf 17-story building which they recently regained control over in October 2019 after foreclosing on their prior ground lease. The company seems to be having considerable success in repositioning the property in a manner similar to 10 Grand Central above and I believe their efforts will bear fruit this year (they recently leased two floors to two separate PE shops.

·       A 28.503% interest in The Herald (https://www.theheralddc.com/), a 106,700 sf office building in Washington DC purchased in March of 2020.  While they are still in the process of renovating the property, roughly 22k sf have been leased and demand is reportedly strong.

·       A 26.8% interest in Peachtree Street, a roughly 42k sf office/retail building complex in Atlanta. While the primary building is a heritage property that is being rather attractively repositioned into creative offices, this property is not a huge value driver for the company. I bring it up because it is mostly notable for its location: Atlanta. Merchant National Properties has recently iterated a focus on three real estate markets: NYC Metro, Washington DC, and Atlanta.  To date, Peachtree Street is their single Atlanta property, but it likely presages additional investments into the market.

In total, 74% of the company’s SF are in NY Metro, DC, and – at 2% – Atlanta.  NY is the overwhelming leader with 67% of the total SF owned (and a higher-still percentage of value). Many of Merchant’s properties (particularly in NY) have been owned for decades and doubtless have appreciated dramatically since they were first bought.

I anticipate MNPP winnowing down the 26% not in these focus markets in favour of NY Metro, DC, and Atlanta. Indeed, the company just sold its single property in Texas, doubtless with the intention of using the proceeds in a 1031 to buy into the target markets (as it did for its property in Miami Beach).

So what does all this real estate get you? Well for the nine months through September of 2021, the company earned $197/share in operating income (albeit $60 of that came from the sale of a building in Miami Beach). For the nine months through September, Merchants has EPS of $174.93 (admittedly augmented by a roughly $2.2m realized gain from its securities portfolio in addition to the benefit of $7.3m in unrealized gains).

As alluded to above, Merchants owns its own management company which for years was run – essentially – as a not-for-profit benefiting the properties it managed (which were largely co-owned by employees and the families of the founders). Recently, however, this has changed leading to a rather dramatic increase in revenue from this part of the business: in 2017 Merchants received just over $3m, while in 2020 it took in a bit over $7m. This increase was due both to raising fees to a more appropriate level for existing properties as well as taking on new ones (most notably the Cross County Center in 2020 as well as The Herald). With a new focus on bringing in institutional co-investors on properties (The Herald, above, is 70% owned by Invesco) this should remain a growth area for the company.

Clearly all this stuff is worth a lot more than the current offer of $1,750, so why does it trade there?

Well, for starters, it’s essentially controlled by the founding families and they don’t always seem to have the same goals and pull in the same direction (attending the annual meeting is well worth it and quite eye opening).  Additionally, the company itself doesn’t have control over all of its real estate interests, and the other owners often seem not to be on the same page as the company. Consequently, it can be a bit trapped in some of the properties it owns (over the past few years management has been working to slowly winnow out small stakes in less important properties and consolidate control over what they can, but this process will take some time).

On the positive side, management has clearly improved over the last five years – Craig Deitelzweig, the CEO – is a real plus and a huge improvement over the previous CEO. His work on 10 Grand Central has doubtless materially improved the value of the property. Likewise, his work on 545 Madison, The Herald, and Peachtree seems promising.

The company pays a reasonable dividend – $65 last year – and aims to raise it over time. $65 equates to a 3.7% yield or so at today’s price.

Catalyst

Really not much of one. I think this will still be around in 20 years. Really it's just a cheap collection of assets and management has improved of late. Plus, you get a dividend which will grow over time.