Northstar Realty Europe: Strategic Alternatives Review Deadline Approaching

• Northstar Realty Europe is approaching the 6/30 deadline for conclusion of its review
• Sale or liquidation of the company should deliver $17-18.50 to shareholders
• High overhead and small scale make it unrealistic for the business to continue in its current form
• Interests of management and major shareholders are aligned in favor of a transaction

Northstar Realty Europe (NRE) announced on 11/7/18 that it was “conducting a process to review strategic alternatives, including considering a potential sale of NRE, in an effort to maximize shareholder value“.  An agreement with NRE’s manager, Colony Capital (CLNY), includes a management contract termination fee and transition arrangements if a transaction is agreed by 6/30/19 (LINK).    NRE has already sold over $1Bn of property at or above NAV over the past year and at 3/31/19 held $9.10/share in unrestricted cash as part of its $20.48/share Net Asset Value.  The remaining properties are in core areas of attractive Northern European markets and should be appealing to conservative long-term investors.  The final outcome of the review should provide shareholders with proceeds in a range of $17.07-$18.48.   Bloomberg reported in April (LINK) that Axa, Schroders, and others participated in a second round of bidding.      In the unlikely event that the company continues to operate without any sale or liquidation the share price could fall to about $14.

Topics:

• Valuation
• Role of Management and Major Shareholders
• Possible Transaction Structures

NorthStar Realty Europe Corp. (NYSE: NRE) is a European-focused commercial real estate company with predominantly high quality office properties in Germany, the United Kingdom and France, organized as a REIT and managed by an affiliate of Colony Capital, Inc.  Additional information is available in prior Koneko articles, NRE’s SEC filings, website, conference call transcripts, and 1Q19 Financial Supplement.

VALUATION

NRE’s calculation of Net Asset Value is based on European Public Real Estate Association standards and reflects the fair value of investments properties based on current usage.  Fundamentals in NRE’s markets remain very strong.

One could imagine adverse developments based on headlines about trade conflict, Brexit and so on, but property values are strongly supported by low vacancy, limited new supply, and very low bond yields.  Cushman & Wakefield summaries of NRE’s markets in 1Q19:

NRE cleaned up its portfolio through sale of its largest asset last year (LINK) and several small assets in 1Q19 (LINK).  One industrial asset (Marly) was “held for sale” at 3/31/19 and there were 2 hotels in Berlin owned on a net-lease basis.  The remaining 12 office properties at 3/31/19 had 97% occupancy and a 5.9 year weighted average lease term.  The one significant upcoming vacancy with BNP Paribas at Berges de Seine in Paris has potential to deliver an increase in rent and appreciation of “fair value” due to strong market conditions.  That lease expires this year, but BNP has little choice but to seek renewal until 2022 because expected completion of its new building has been delayed.  Sale of NRE’s core office portfolio as one package could garner a slight premium to stated NAV from a long-term investor such as an insurance company, pension fund, or sovereign wealth fund.

Nervousness over the economic outlook has had a bigger impact on listed REITs than on property assets.

While the outcome of NRE’s strategic review is not yet known, property market strength ensures that attractive options must be available.

ROLE OF MANAGEMENT AND MAJOR SHAREHOLDERS

NRE held good quality assets in attractive markets, but delivered a poor shareholder return due to high overhead, small scale, and lack of US investor interest.  These parties are in a position to influence the outcome of the strategic review:

• Senvest Capital (8.6% owner) – The company’s largest independent shareholder (excluding Blackrock which holds shares because NRE is in the Russell 2000 index) filed a 13D on 9/24/18 pushing for sale or liquidation (LINK).  Senvest argued that sale of assets and distribution of proceeds would minimize the liability for change of control payments.
• Colony Capital (11.3% owner and manager) – Colony will essentially receive 5 years of fees (5x$14mm) as compensation for termination of the management agreement.  High overhead, small scale, and US listing left little likelihood that NRE would have been able to grow AUM over time.  With payment of the termination fee Colony’s sole remaining interest is in maximizing the value of its directly owned shares.
• Management – Managers would receive change of control payments and vesting of share-based compensation upon a sale or liquidation.  It would be difficult for them to reach their performance incentive thresholds without a strategic transaction.

POSSIBLE TRANSACTION STRUCTURES

NRE’s strategic review is likely to compare transaction structures that would appeal to different types of buyers:

• Outright sale – could be appealing to an asset manager seeking to acquire NRE using stock.  NRE’s cash balance would add to the buyer’s AUM and long-term revenues.  A sale could probably be completed around the end of 3Q19.   However some potential acquirors might not pay full value if they are not interested in all of NRE”s assets.
• Liquidation – sale of NRE’s properties in one of more individual transactions could maximize the proceeds by placing each asset with its optimal buyer.  For example, a particular buyer might offer a premium valuation for only the office properties and not want the hotels.  Or another buyer might offer a premium price for the German offices, but not the UK locations.  After a lengthy strategic review NRE is probably in a position to make significant sales by the end of 3Q19, however liquidation of the entire portfolio could take up to 12 months.  Shareholders could receive most of NRE’s current cash balance through an initial liquidating distribution of about $7 as soon as July ($453mm – $65mm termination fee – $25mm  reserve = $363mm).  A second distribution could follow significant sales about three months later and then smaller amounts as remaining assets are sold and corporate obligations resolved.  I believe that liquidation of NRE would be accompanied by internalization of its management.

If NRE opts not to sell or liquidate then shares would return to a substantial discount to NAV.  NRE is too small, overhead is too high, and NYSE listing does not reach a suitable base of investors.  It does not make sense to own assets with a 3% yield through a REIT with over 3% overhead.

DISCLOSURES

The author is a shareholder of NRE.  The author does not make any recommendation regarding any investment in any company mentioned in this article.  Investors are encouraged to check all of the key facts cited here from SEC filings and other external sources prior to making their own investment decisions.