Artis REIT: Spin Spin Sugar

• Artis will spin off its Retail assets to unitholders through a new listed REIT
• Artis will separate its Industrial assets into a wholly owned structure to facilitate a future spinoff or sale
• Artis attributes $2.55/unit value to the Retail business. The remaining $12.85 of NAV is about $7 for Industrial and $6 for Office.
• Management accepts that diversification depressed shareholder value

Artis (TSX:AX/UN) units fell in March after the company’s Strategic Review concluded without announcement of a major transaction, but this week’s news demonstrates that management and board are on a path to deliver the company’s fair value (IFRS NAV of $15.40/unit) to investors. The modest reaction from investors seems to put too much weight on the limited initial appeal of the Retail REIT and too little on management comments about future plans to undiversify, likely through spinoff of the Industrial business.

SPIN: Key aspects of the Retail Spinoff (AXX.UN)

• Unitholder Vote 4Q20 and closing 1Q21
• Spinoff to current Artis common unitholders
• Artis preferred holders will not have any interest in the new company
• 54% Alberta, 19% Manitoba and 27% Saskatchewan
• 91% occupancy and 95% rent collection in August (far above peers)
• 92% Open-Air and 8% Mall, but the company expects to sell the mall (in Regina)
• IFRS fair value $779mm at 6/30 or $2.55 per current Artis unit. Valuation is equivalent to about a 6.6% cap rate which incorporates an assumption of lower near-term NOI due to higher vacancy allowances.
• Will pay Artis REIT management fees equal to 0.35% of Book value plus 3% of revenue
• Expected payout ratio of 60%. Combined AX+AXX distributions after the spinoff will be at least equal to the current level.

See the press release, presentation, and conference call for additional detail.

SPIN: New disclosures about future plans to deliver full value to investors

• In addition to separating its Retail assets for spinout, Artis will also create separate legal structures for its Office and Industrial properties

Management explained: “We’re creating new LPs, pure play, for the industrial and the office.  And the US will have pure-play sub-REITs that will hold the industrial property separately and the office property separately making things more efficient and easier if there is ever opportunity for M&A”

• Conference call comments from Artis management show the company will give up on the diversified business model which depressed the unit price:

“It’s just structural.  Investors everywhere from Toronto to Red Deer, New York to London to Singapore.  Institutional investors have made a decision to strongly prefer pure-play REITs.”

“There’s an old saying the customer is always right.  And if the investors want pure-play REITs then that’s the direction we have to go in order to increase unitholder value”

“If we waited, if we wanted to spin off all 3 [asset-types] we would have to sell more properties first to improve our balance sheet more.  We’re not quite there.  We didn’t want to wait another year for all the stars to align perfectly.  This is something we can do now, and it will be the right thing to do, a step in the right direction.  And then if [our price multiple for Artis REIT] doesn’t improve, bring us to NAV, then as we sell down properties and improve that balance sheet, we’ll definitely look at splitting into 2 more REITs [Office and Industrial].”

“A year ago we would have probably spun off industrial first, along with an IPO even and raised money because of the strong demand.  In these post-COVID times, it’s become more evident that retail is a concern for investors.  You’ll realize it’s not a concern when we separate it and put it in an independent REIT because it’s very good retail that performs well.  And we don’t need the highest price multiple to benefit from it.  Retail is what we can do now, but yes, we did contemplate industrial in the past year as well.”

SUGAR: Valuation

Artis own $15.40/unit NAV calculation is the best guide to what the company is worth. The valuation incorporates detailed information about lease terms, tenant quality, and conditions in every property market. Some companies (e.g. Morguard) were slow to update their NAVs this year to reflect the impact of COVID, but Artis promptly reduced valuations in 1Q20. The overall prices realized by Artis from property disposals since 2018 have been in line with carrying values.

Brokerage analysts independently estimate Artis NAV between $13-14, but they have less information than the company and make broad estimates. On the conference call one analyst asked what were the top tenants in the Retail properties and the company replied:

“We’ve got some grocery tenants, and drug stores and liquor stores of course, and a lot of personal service tenants form the bakery to the chiropractor to the hair salon to the dentist and the doctors and then the bars and the restaurants.  We probably could have done a better job to give more detail on that, and we will going forward in terms of the retail tenant mix.  When we’re a pure-play retail REIT all of this will be in the MD&A.”

Transformation of Artis into pure-play REITs will provide additional transparency that will enable analysts and investors to better understand the value of these assets.

Artis attempted to benchmark its sum-of-the parts valuation using Canadian listed peers:

This provides a helpful validation of the company’s own NAV estimate, but has two significant problems 1) the number of benchmarks in the Canadian market is very small and 2) Artis received 53% of its 2Q20 Industrial NOI from the US where benchmark valuations are much higher (over 20X FFO).

Undiversification will provide greater transparency into Artis assets enabling analysts and investors to value them more accurately. The company’s internal restructuring will also simplify the sale of its US/Canada Office/Industrial properties if a private bidder offers a superior price for any of those 4 units.

Investment Considerations

Artis continues to pursue asset sales that will reduce its Debt/GBV to 46% by 2Q21. Disposal of $550 mm of assets could reduce FFO by $0.03/qtr which would be partially offset by income from newly completed industrial properties.

Insiders have bought C$923,599 of units in open market purchases since Artis announced 1Q earnings in May. A 12000 unit buy on 8/20 by independent Director Ben Rodney looks inappropriate. Was he aware at that time that the company would soon announce an undiversifcation plan to deliver value to unitholders? Director Bruce Jack and CEO Armin Martens waited to make purchases until after the news was out this week.

Many analysts and investors failed to appreciate the important role played by Sandpiper Group which disclosed ownership of 4.5% of Artis units in 2018 and recommended the addition of a trustee (Lauren Zucker) with a strong background in international real estate finance. The largest Artis unitholder is the Estate of Tim Hortons co-founder Ron Joyce which held an 11.2% stake as of 8/10. Combined insider ownership of about 1% is too low to block actions that will deliver value to unitholders.

One way or another Artis unitholders should expect to see the $15.40 fair value of their investment recognized in the market. It may come through the transparency and investor appeal provided by listing of pure-play REITs. It may come through a third party bid for any portion of the portfolio whose value is not recognized in the public market. The Retail REIT is likely to initially trade below NAV in the typical pattern following a spinoff, but the much better than average rent collection suggests the price should not get too low. Artis Industrial assets could probably sell above NAV to a buyer attributing value to the development pipeline.

Disclosures

The author is a unitholder of Artis REIT.  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 SEDAR filings and other sources prior to making any investment decisions.

The quotes in the pictures are from the linked songs about spinning rather than public statements by Artis CEO Armin Martens.

The quotes in the text from the 9/8 conference call were slightly edited for clarity. Investors are strongly encouraged to read the transcript or listen to the call because it provides more detail about the intention to undiversify than was included in the press release and presentation.