Colony NorthStar Inc (NYSE: CLNS) is a global real estate and investment management firm that invests in real estate and real estate-related assets. The company was created in early last year through a three-way merger of Colony Capital, NorthStar Realty Finance, and NorthStar Asset Management. RiverPark Advisors, an investment firm based in New York, discussed its investment thesis on CLNS in its Q1 Focused Value Fund Investor Letter. According to the letter, a transformation plan – presented by management last year to transform the company from primarily real estate ownership to a more capital-efficient opportunistic real estate asset manager – “has not been as smooth” as it had hoped and some of its “original estimates of value have proven to be optimistic.” Let us take a look at RiverPark’s comments about Colony NorthStar to learn about the investor’s viewpoint about the company.
Here are the comments:
[Colony NorthStar] has a somewhat complex structure: owned real estate in three market segments: healthcare, industrial, and hospitality; an investment management business; and a portfolio of other investments. At the time of the merger, management presented what at the time seemed like a credible plan to transform the company from primarily real estate ownership to a more capital-efficient opportunistic real estate asset manager. This transformation was to be achieved through asset sales, the transfer of owned assets to managed vehicles, and organic growth in the investment management business.
If management had achieved these objectives, it would likely have resulted in higher margins, more stable earnings, and a better valuation multiple. We thought it reasonable for a “transformed” CLNS to trade at more than $20 per share, up about 50% from our initial purchase price, as the company would be valued based on a multiple of cash flow/funds from operations rather than on the basis of Net Asset Value (NAV), that is, total assets minus total liabilities. Further, the dividend yield of nearly 8% enhanced our projected total return to nearly 60%.
During the first nine months of Colony’s existence as a public company, developments unfolded consistent with management’s plan as they announced the sale of certain owned assets to a managed vehicle, the divestiture of a non-essential division within asset management at an attractive valuation, and the realization of post-merger synergies.
During the fourth quarter conference call held in March, however, management made several announcements demonstrating that progress towards its pre-merger strategic initiatives was going to take longer than we had previously anticipated. Returns on the investment portfolio would be lower in 2018 than 2017, income from asset sales was delayed, and most importantly, growth in the asset management business was lower than expected. They also reduced the quarterly dividend from $1.05 per share to $0.44 per share. In response to these announcements, the stock declined by an additional 25% from approximately $8 to less than $6.
Clearly, the transformation process has not been as smooth as we had hoped and some of our original estimates of value have proven to be optimistic.
In aggregate, our estimate of value has declined from more than $12 per share when we initiated the position, to roughly $9 today, with more than 40% of the decline attributable to the investment management business and about 35% to reduced valuations in healthcare and hospitality. At the same time, the stock price has declined from $12 to less than $6. Normally, when we find that the underlying value of the assets is far greater than the current stock price (as we discussed above with respect to MIC), we view that as a buying opportunity. Here, however, our initial assessment of Colony’s management as smart, opportunistic investors has been somewhat shaken by our recent experience. Tom Barrack, the CEO, highlighted his personal commitment to resolving the merger issues, and we are convinced that he is both sufficiently and properly motivated to fix the problems. Given his prior track record, we remain invested in CLNS (although the position has been significantly reduced) while we wait for some evidence that his do/say ratio will improve. Should we observe successful execution against this plan, we remain open to increasing our position.
Explaining the “do/say ratio”, RiverPark said:
We believe that the very best management teams tell us what they plan to do and then successfully do what they say. We prefer consistency in these plans, as has been the case with MPC [Marathon Petroleum Corp.] since 2011, and coherence across various methods of communication and action. We like companies, like CarMax, where the message of success through building a superior and differentiated customer experience, is the same when communicating with customers, employees, and investors.
The do/say framework has helped us think more clearly about investments we have made throughout our careers. In retrospect, many of our most successful investments had management teams with high do/say ratios. Sometimes a company’s previously high do/say ratio declines over time, and in those cases, we would generally have been well served to be more skeptical in the reassessment of our investment thesis.
Going forward, we will continue to increase our exposure to certain investments and decrease exposure to others based on application of the do/say framework.
For the first quarter of this year, Colony NorthStar Inc (NYSE: CLNS) reported a net loss of $72.7 million, versus a loss of $5.22 million in the same quarter last year. Per share loss was $0.14, versus a loss of $0.01 per share last year. Revenues were arrived at $666.66 million, up compared to $607.17 million in the 2017 quarter. The company recorded total expenses of $851.85 million, which were higher than $712.17 million reported last year.
Meanwhile, investors don’t seem happy with the company’s performance if we look at stock charts. According to Morningstar, CLNS plummeted more than 28% over the past three months, and more than 55% over the past 12 months. For the stock – which is trading at $6.00 – the consensus average recommendation is ‘Buy’, while the consensus average target price is $8.60, based on analysts polled by FactSet.
Meanwhile, Colony NorthStar isn’t very popular stock among hedge funds tracked by us. As of the end of 2017, there were 26 funds in our database with positions in the company.