这些来自Colony Capital的7.8%收益率候选人准备走高

Since we first recommended Colony Capital preferred shares, they have seen modest appreciation.

A major transaction is going to have a significant impact on the company.

Having achieved top dollar, CLNY now has to decide how to allocate the profits.

We believe a call of high-coupon preferred shares is likely to be part of the decision.

The discount on the lower coupon shares is going to end.

Co-produced with Beyond Saving and PendragonY

We are always on the lookout for mispriced high yield opportunities to recommend to our investors, with the objective to buy and hold for the very long term and collect high income. We first identified and recommended the Colony Capital (CLNY) preferred shares in March 2019. At that time, series H, I and J were trading around $22. Today, all three trade over $23, providing us with an unrealized capital gain of over 4.5%, plus receiving an effective yield over 8%.

CLNY is one of the largest real estate owners in the world. They have accumulated a vast portfolio of properties around the world that is reported in four segments - Healthcare, Hospitality, Industrial and “Other Equity & Debt”. CLNY has $55 billion in assets under management. In addition to properties that they own, they also provide external management for Colony Credit Real Estate (CLNC).

CLNY’s common share price started falling after a complex merger with NorthStar Asset Management and NorthStar Realty in January 2017. Recently, CLNY has been working at divesting their eclectic collection of real estate, in an effort to make the company more streamlined and less complex.

The things that attracted us to CLNY's preferred share offerings were the sheer size of CLNY and a debt structure that relies primarily on non-recourse mortgages, providing a solid and diverse base of assets. CLNY also has plenty of cash flow to cover their preferred dividends. This ensures that CLNY will easily maintain their preferred dividends while also having substantial asset value for recovery in a black swan event.

While the common shares have been volatile and experienced downside due to the perceived lack of direction and lack of clarity, the preferred shares benefit from such a large asset base. CLNY has been selling off properties, and they have been getting great prices. While the common shares have great potential upside, that upside relies upon good execution. The preferred shares offer less volatility and more security.

There has been a recent large asset sale that materially impacts CLNY's asset base, making it important for us to reassess our position.

CLNY put their industrial portfolio up for sale in June, less than 4 months later, they sold the portfolio for $5.9 billion. This is a fantastic price for CLNY as their book value for the assets was only $4.1 billion. The deal includes the assumption of slightly over $2 billion in property-level debt.

Source: CLNY Supplement

With property-level NOI just under $250 million/year, CLNY is realizing a cap-rate of approximately 4.2%. A high price even in today's rather pricey industrial market.

The goal is to buy low and sell high, while arguably CLNY was not exactly buying industrial at "low" prices, they have managed to sell the entire division for much higher than they paid for it. This is great news for CLNY common shareholders, as it is a significant step towards simplification with a very nice profit.

For preferred shareholders, it has the impact of immediately deleveraging and expanding the balance sheet. Additionally, there is a very high chance that some of CLNY's outstanding preferred issues may be called.

In their 10-Q, CLNY states,

Most of CLNY's debt is property level non-recourse debt.

Source: CLNY 10-Q

Non-recourse debt generally cannot be paid until maturity. For their recourse debt, the largest debt CLNY has is their convertible notes. The nearest maturity is approximately $400 million maturing in January 2021, and CLNY is not allowed to call it early unless the common stock trades at 130% of the conversion price ($16.57) for 20 out of 30 days.

Their Junior debt matures 2035-2037, so there is no reason to pay that back.

That leaves their revolving line of credit which only has $85 million and their secured debt, which is a loan on their corporate jet for $36 million. The revolver will probably be paid off, but is not large enough to materially impact leverage.

We believe it makes more sense for CLNY to look at the preferred level of their capital stack to deleverage from the common shareholder's perspective. The preferred shares that are currently callable include:

CLNY could redeem all of these for just under $500 million. With the sale of the industrial portfolio, combined with the closing of the sale of NorthStar Realty Europe (NRE), which netted them a total of $160 million in termination fees and proceeds from the shares they held, CLNY will certainly be in a position to redeem them and have cash leftover to redeploy.

We expect that

CLNY.PB

and

CLNY.PE

will be called early next year, shortly after closing the industrial portfolio.

CLNY.PG

is somewhat murkier, and we can imagine CLNY allowing the G's to continue.

CLNY has three other preferred shares that are not yet callable:

Looking at the remaining preferred, we can see that they have much lower coupons. While the higher coupon

CLNY.PE

and

CLNY.PB

have consistently traded at or above par value, these preferred shares have traded at a discount.

That should be expected because investors would be able to obtain a higher yield from the same company by choosing E or B over their peers if they traded for the same price. Either E & B would need to trade at a higher price, or the lower coupon preferred shares need to trade lower. The threat of a call any day has prevented the price of E or B to rise materially above par. This forces the lower-yielding coupons to trade at a lower price, so that their yields are more competitive.

Nobody would settle for a 7.125% yield when they can get an 8.5%+ yield on the same investment!

If B and E are called, then G becomes the highest coupon. Instead of trading down to compete with an 8.25% or 8.75% coupon, the highest coupon outstanding would be 7.5%. If CLNY decides to call the G as well, then CLNY.PI becomes the highest coupon outstanding. Without the alternative to invest in a higher coupon with the same company, the share prices of H, I and J would be free to move much closer to or possibly even above $25.

CLNY already had strong asset coverage, last quarter, they had $22.6 billion in assets and $12.1 billion in liabilities. More than enough to comfortably cover their $1.4 billion in preferred equity. After the transaction, their total liabilities will be $2 billion lower, while their assets will be higher due to CLNY selling the properties at greater than book value.

It is very likely that CLNY will redeploy some of the proceeds and will use new property-level debt to leverage those funds. The initial math suggests that debt + preferred will be covered by assets over

2.3x

. We expect that will trend toward 2x as CLNY redeploys their funds.

As of last quarter, Core FFO covered the preferred dividend by

3.1x

though it has failed to cover the common share dividend. The industrial sale in the near term will reduce FFO until the funds are redeployed or used to further reduce debt. We anticipate cash flow coverage will tighten for a quarter or two. However, with such a low cap rate achieved on the industrial portfolio, CLNY should be able to redeploy the funds into much higher yielding returns. Any redemption of the higher coupon preferred shares will improve cash flow coverage. We believe it is very likely that the common dividend will be covered when the funds are redeployed.

CLNY is on the right track. They had stated earlier in the year that they intended to sell non-core assets to obtain at least $500 million in excess proceeds. The NRE sale was a step in the right direction, then they saw an opportunity with the industrial portfolio to achieve a large return while prices are high, dwarfing their original $500 million goal.

CLNY has suffered from needless complexity and high leverage on their properties. The industrial sale goes a long way towards resolving those issues by selling an entire segment at a gain to book value.

It is very likely that they use some of the proceeds to deleverage in order to improve cash flow to common shares. Redeeming some of the preferred shares is the obvious route to achieve that.

We have positioned ourselves in

CLNY.PI

and

CLNY.PJ,

the best buys followed by

CLNY.PH

. We expect these shares will experience capital appreciation of

over 8%

to $25 par and possibly even more, while paying us a current yield of

7.8%

.

This is a deal that will not last long

, it will end when CLNY announces the redemption of

CLNY.PB

and

CLNY.PE

. Buy the CLNY preferred before it is too late!

I am/we are long CLNY.PI, CLNY.PJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.