Colony Credit: Hoping the End Is Near

  • Colony Credit reported non-disastrous 4Q19 results with $0.37 Core EPS and undepreciated book value of $17.81/share
  • Colony Capital announced that it intends to sell its agreement to manage Colony Credit
  • Colony Credit hired brokers to sell The Row NYC Hotel
  • CEO Kevin Traenkle resigned

the-end-is-near-rhyme-wither-ange-coav-this-will-215507884Q19 results (press release and conference call) came with no major surprises, but after $725mm of writedowns the credibility of Colony Credit’s management is too low to celebrate their numbers.  Colony Capital’s willingness to seek a sale of Colony Credit is likely to result in a much better outcome than the Internalization that was proposed in November.

Asset Quality

CLNC reported no loss provisions or impairments in 4Q19.  At year-end the company had two loans past due (one new and one old):

CLNC Past Due 4Q19

  • “we placed on non-accrual status one loan secured by a hotel (“Midwest Hospitality”) due to a borrower default during the fourth quarter of 2019. We are sweeping cash from the hotel to amortize the unpaid principal balance of the loan.”  The hotel is in Bloomington MN
  • “In March 2018, the borrower on our four NY hospitality loans in our Legacy, Non-Strategic Portfolio failed to make all required interest payments and the loans were placed on nonaccrual status. These four loans are secured by the same collateral. We believe ultimate sale of the underlying collateral and repayment of the loans from the sales proceeds is the most likely outcome. During 2018, we recorded $53.8 million of provision for loan losses to reflect the estimated value to be recovered from the borrower following a sale. During the year ended December 31, 2019, we recorded an additional provision for loan loss of $154.3 million based on significant deterioration in the NY hospitality market, feedback from the sales process and the estimated value to be recovered from the borrower following a potential sale.”  A Wall Street Journal story confirmed that this loan package is backed by The Row NYC Hotel (WSJ: Defaults Are Rising in Sluggish New York City Hotel Market).

Colony Capital Seeks Exit

CLNY filed an amended 13D on 2/26/20 disclosing new intentions for its stake in CLNC:

Colony Capital currently plans to dispose of its management agreement with the Issuer. In connection therewith, the Reporting Persons plan to take any and all such actions as may be necessary or appropriate for Colony Capital to enter into an agreement with the Issuer and/or one or more third parties with respect to a disposition of such management agreement, whether in the form of an internalization of the management of the Issuer (including, but not limited to, the possible internalization set forth in the non-binding letter that Thomas J. Barrack, Jr., the Executive Chairman and Chief Executive Officer of Colony Capital, delivered to the Issuer’s independent directors on November 6, 2019, which was included as Exhibit 99.2 to Amendment No. 1 to the Schedule 13D and is incorporated herein by reference), a sale of Colony Capital’s management agreement with the Issuer, or a similar transaction the effect of which is to dispose of Colony Capital’s management agreement with the Issuer. The scope of such transaction is focused on Colony Capital’s management agreement with the Issuer, and not Colony Capital’s private credit investment management platform and associated private credit assets.

Sale of the management agreement would have significant advantages over the Internalization transaction proposed in November.

  • CLNC shareholder approval would be required for a sale.  If the new manager did not present a convincing plan to raise the value of CLNC shares then the transaction could be rejected.
  • CLNY dropped the plan to sell its credit asset management business to CLNC.  Valuation of that business would have been difficult and investors would probably not have attributed any value to it.
  • Sale of the CLNC management agreement could be in conjunction with a share-based acquisition of CLNC by a listed peer such as Starwood, Blackstone, or Apollo.  CLNC investors (including CLNY) would receive liquid shares that are fairly priced. The external manager of the acquiring company would enjoy a big increase in fee-paying in Assets Under Management.  Shareholders of the acquiring company would benefit from accretion in Net Asset Value per share.
  • Sale of the CLNC Management Agreement to another manager would deliver immediate value to CLNY and could deliver improved value over time for CLNC shareholders.  Some examples of prior transactions:
    • the acquisition of American Capital by Ares Capital in which Ares Management paid $275mm cash to acquire $1.7Bn of new equity under management
    • the acquisition of the Fifth Street Finance and Fifth Street Senior Floating Rate management agreements in which Oaktree paid $320mm to acquire $1.3Bn of new equity under management.
  • CLNY’s 36.5% equity interest in CLNC is worth more than the CLNC management agreement so the interests of CLNY are aligned with CLNC’s public shareholders.
  • CLNC continues to be valued at a very large discount to all peers.  A transaction should deliver between 75-90% of book value ($13.35-16.03/share) to CLNC shareholders.  Note this table is based on the panic pricing at the 3/9/20 close.

CLNC Comps 030920

Disadvantages of the Internalization proposal:

  • CLNY said that an Internalization agreement could be implemented without shareholder approval
  • External management is standard for commercial mortgage REITs.  There is no reason to believe that investors would attribute any value to Internalization.
  • CLNC’s management has been terrible.  The company has no credibility with investors and its valuation would remain heavily discounted so long as the same team was involved.
  • Internalization would leave CLNC with a large overhang of the shares that CLNY wants to sell as part of its transition to a digital strategy

CLNC on Death Row

The $258mm Times Square “Row NYC” hotel loan package on which CLNC has recorded $208mm of loss provisions is for sale.  It’s not a great time to be selling a hotel.

CEO Resignation

I believe that Kevin Traenkle was responsible for the overstatement of the value of CLNC’s assets from the time of its formation and then repeatedly misrepresenting to shareholders that the values were accurate.  The 4Q19 conference call gave him one last opportunity to repeat his lame explanation that CLNC was not buying back its discounted shares because “we think that there are still some very compelling investment opportunities out there in terms of making loans and some good pipeline“.

Disclosure

At the time of publication I own shares of Colony Credit Real Estate.  This disclosure should not be interpreted as any recommendation regarding investment in those shares.  My holding could change at any time after publication.

2 thoughts on “Colony Credit: Hoping the End Is Near

  1. In my opinion Barrack was responsible for booking the assets acquired from Northstar Incomes 1 & 2 at values far in excess of fair values, IMO, to cover up the screwing he took from Hamamoto by paying way too much for NSAM (which included management of junk assets inside Incomes 1&2) because he was too busy flying all around the country for Trump’s 2016 campaign on CLNY’s private jet at the same time CLNY was negotiating the CLNY/NRF/NSAM merger. Traenkle, imo, just obeyed his boss.

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    1. If they had forced NRI1&2 to write down the assets when CLNC was formed then this could have been a growing company and the management contract would be more valuable.

      Traenkle was paid $3mm/year. He signed off on the financial statements and asset over-valuations. From the start he promised quick action on new portfolio investments and resolution of “non-core” assets and failed to deliver. He repeatedly assured shareholders that impairments were over. I don’t feel sorry for the guy.

      My November letter to the Independent Directors may have had an impact in pushing the company away from the Internalization proposal.

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