Colony Capital’s Shareholders Focus On Diversified Strategy

Activistmonitor – February 2019

Colony Capital’s [NYSE:CLNY] diversified business model is one of the issues it needs to address to see any progress in improving shareholder returns, said Geoffrey Dancey, managing partner at Cutler Capital Management. The Worcester, Massachusetts-based investor increased its ownership in the real estate company during the fourth quarter of 2018. Cutler is also a bondholder.

Colony’s inability to make its USD 19.9bn tri-party merger with NorthStar Realty Finance and NorthStar Asset Management succeed as much as advertised continues to weigh on investor sentiment, he said.

Underpinning Blackwells Capital’s engagement with Colony, initiated by Blackwells CEO Jason Aintabi last September, is growing recognition that combining commercial, industrial, and residential properties, as well as an asset management business focused on real estate, is hurting the stock price.

On 11 February, Colony appointed two new independent directors to its board and said it had formed a Strategic Asset Review Committee as part of a cooperation agreement with Blackwells, which owns 2% of the company.

Blackwells and Colony will agree on an additional board appointment and the committee will recommend asset and business configuration changes to the board after evaluating the business portfolio.

Colony’s struggles have played out amid a broader shift in investor sentiment toward diversified REITs. Unlike a few years ago when most REIT investors tended to be a tight group that supported management and were happy to take their dividends, investors now want a REIT that’s focused in one kind of property category such as commercial or residential, free of the problems with misweighting and complex structures that are difficult to fathom, according to people familiar with the situation.

Colony’s portfolio combines healthcare-related properties such as skilled nursing facilities with hotels, plus warehouses and other industrial properties, as well as some apartment buildings. It requires extra work to understand, and that can depress the share price, said one sector investor.

Cutler had expected Colony to focus more on disposing legacy assets, including properties in its hospitality and healthcare segments. Colony would like to remain in those businesses, “but some portions of those that don’t allow for third party co-investments, so they’re looking into selling some of those assets,” Dancey says.

Another reason to sell some assets in those segments is the substantial floating rate debt associated with them – about USD 2.6bn in hospitality and more than USD 1bn in healthcare. Colony’s floating rate debt was adversely impacted during the third quarter as a result of Libor rate changes and the company is trying to convert some of its floating rate debt into fixed rate notes, Dancey says.

Colony’s portfolio issues are more complicated than those of most REITs, however, and won’t be solved simply by spinning off assets, some sector investors said.

The investment management business, which generates considerably more revenue than any of Colony’s property portfolios, relies on the ability to raise money. That isn’t easy without being a very large real estate company with broad access to capital markets, a second sector investor said.

Barrack part of the company fabric?

Another factor weighing on Colony’s valuation is the headline risk surrounding founder and chairman Tom Barrack, who returned as CEO in November. A long-time ally of President Trump, Barrack chaired his inauguration committee. Federal prosecutors are investigating the USD 107m raised and spent by the committee for potential illegal fundraising activity.

While it’s debatable whether Barrack’s more active role will boost Colony’s headline risk, it’s not clear whether Blackwells, or other shareholders, would want him out of the picture, shareholders and sector investors said.

For all the unwelcome scrutiny of the inaugural committee probe and Barrack’s admitted miscalculation regarding the NorthStar merger, he is widely recognized for his business acumen and international connections, upon which Colony’s success in attracting co-investment funding largely depends.

Citing Barrack’s own financial losses and his eagerness to restore his reputation after the NorthStar mistake, one shareholder said, the pressure he’s under is a good thing. It means he’s more aligned with shareholders’ interests.

Expediting the pace of asset sales, which would likely give the valuation a chance to recover before further negative news concerning Barrack’s political ties surfaces, would be a plus for Colony, and the new board members and the strategic review should facilitate that, said Dancey.

“[Barrack’s leadership is] a difficult thing to handicap in terms of the valuation of the stock,” said Dancey. But the fact that the business transition is being handled by members of the same management team, albeit in different positions, without having to bring in outside help, is positive, he adds.

The mere announcement of the board changes and strategic review likely signals those who may be interested in buying an asset or helping Colony spin it off, one shareholder said. Still, the complexity of Colony’s business configuration means Colony and Blackwells will probably need four to six months to agree on specific actions to take.

Despite its inability to scale up the investment management business as quickly as anticipated, Colony’s business model is conceptually appealing, says Mitko Botev, a portfolio manager at Cutler.

“Where they’re raising money publicly and privately and to have ownership stakes in multiple areas gives them an advantage in market intelligence,” he says. “But what level of capital commitment do they need in each area to achieve that information advantage?”