Rating The IPO
Note: "Before IPO" and "After IPO" measure the use of the proceedings to enhance revenue growth. A small difference between the two Xs means funds from the proceedings probably will have little effect on the index.. Rating Scale
Prediction Expect at most 20% stock price appreciation. Its dividend may add another point or two to the total return. If they complete their first cycle of acquisitions in ’98, and if the stock opens at $15, then it could be $18 by the end of Year 1. |
Comments The initial sellers will receive "Units of the Operating Partnership," which are redeemable after two years either for cash or for shares of common stock. This maneuver is important for the Company and probably for the seller as well. The Company gets to use the $71.3 million for acquisitions, which otherwise would go to complete payment on the initial properties, and the sellers in turn get to defer a capital gains tax. The Company then has roughly $162 million to expand its portfolio. By the laws governing REITs a significant portion of this money must be invested in the first year. If unable to find satisfactory dealerships in that period of time, it may be forced to acquire other types of property, or it will invest the remaining money in government securities. The
Nature Of The REIT Table 1 lists the performance of REITS which IPO’d in 1997. Four of the 9 companies had stock-price growth over 14.3%. At the high end, growth was a robust 88%, whereas price declines were no greater than 6%. Offering prices tended to be high, $18.89 per share, and all but one company trades on the New York Stock Exchange. These figures suggest a measure of strength and stability in real estate trusts. |
| REITs have become
increasingly popular throughout the ‘90s. Already
there are about 200 REITs now trading on the major stock
markets ranging from those focused on apartment buildings
to others on prisons or golf courses. There’s a good
reason for the enthusiasm. In 1996 REITs returned 36% to
the investor when taking into account both the dividend
and the appreciation of the share price (Table 2). Since
1991 total market capitalization has nearly tripled
growing from $56 billion to $162 billion, and the trend
appears to be just at its beginning. The institutionally
owned commercial real estate market has an underlying
value of $1.3 trillion. REITs currently own
only 8% of that market meaning there will be significant
acquisition opportunities for many years to come. Their
Promising Outlook In contrast to other sectors, such as technology and manufacturing, the U.S. real estate industry should be relatively shielded from worldwide economic fluctuations. Revenue from rental property will remain stable, unless the country’s thrown into a serious recession which is not foreseen. Indeed, reductions in new construction since the early ‘90s have resulted in growth in rents and property incomes, and this trend is expected to continue at least until 2000. However, it’s important to emphasize the following point: Given the current uncertainty of the market, the cautious investor must go on the assumption that newly IPO’d REITs will not achieve the capitalization in ’98 which they’ve enjoyed during the past few years. The so-called yield curve, considered one of the more prominent indicators of domestic growth, has been flattening, a sign of a slowdown in the economy. A slowdown could well have a suppressive effect on a REIT’s total return. The
REIT & Auto Dealerships The
Capital Automotive REIT In the beginning dealerships with multiple sites will be preferred. They often have better locations than smaller dealerships, are in better condition, are better managed, and are more successful. It also lets the Company advance its portfolio more quickly with a group of trusted sellers as it attempts to reduce risk with respect to management and location. Nine of the 21 properties will be purchased from John J. Pohanka, 7 from Robert M. Rosenthal, 4 from Vincent A. Sheehy, and 1 from Jonathan K. Cherner and Andrew M. Cherner all of whom collectively "have over 145 years of experience in the automotive industry." All sellers will be compensated in Units, which are redeemable after two years most likely in the form of common stock. The two biggest sellers are Rosenthal with a 16.5% interest and Pohanka with a 5.8% interest. Both of these sellers also will become Trustees with the ability to exercise influence over the affairs of the Company. The obvious concern about initial sellers being on the Board of Trustees is in the potential for a conflict of interest when decisions must be made between their own interests and those of the Company. The concern perhaps should be a minor one in this case. First, the sellers are paid in Units, not cash, which strongly aligns their interests with those of the REIT. Second, any conflicting decisions they may take in favor of their own properties will diminish in overall impact to the Company as the portfolio grows. And third, their experience in the auto industry and their track record of success likely add depth and judgment to the Board. A
Comparison With Other REITs EOP is distinguished by being the largest REIT in the country involving office properties. But PZN and GTA are especially useful comparisons, because they along with Capital Automotive belong to the same segment of the REIT industry, namely those which carry triple net leases. Both PZN and GTA are in the niche markets of prisons and golf courses. It’s worth noting the significant growth that PZN has had, 46%, over GTA’s 24%, even though GTA shows a better financial picture. GTA’s quarterly distribution is higher than PZN, its payout ratio is lower suggesting a greater percentage of funds are held by the company for future acquisitions, and its yield is higher, while at the same time both are comparably leveraged. Clearly, analysts find the future expectations of PZN to be greater than those of GTA. Perhaps the central reason is that the privatization of prisons, and correctional facilities in general, is a growth market. One can assume that the risk of failure for any of these properties is low, because rental payments continue to come from state governments. Further, prisons are multifunctional communities requiring restaurant, laundry, and educational capabilities and, at several sites, manufacturing. PZN has primary or secondary involvement in many of these efforts, which enhances its potential for earnings. |
| In contrast, golf
courses are not as operationally complex; the only source
of revenue for GTA consists of rents from the leased
properties. Nor are courses as resistant to national
economic fluctuations. Any significant downturn in the
economy would be reflected in reduced customer usage. As
it is the addition of several new courses and plans for
several more may put greater competitive pressure on some
of GTA’s properties resulting in lower levels of
revenue, which in turn could keep them from achieving a
breakeven point. These issues describe an industry with a
greater degree of inherent risk than correctional
facilities. Capital Automotive is similar to GTA in its dependence on a single revenue stream from properties that rely on good national economic conditions. A worst-case scenario of a recession potentially could drive some of the weaker dealerships into default. If this were to happen during the period when the portfolio is small, the negative impact on the REIT could be sizable. Such a scenario is extreme and not foreseen. However, it emphasizes the dependence of the Company on all properties operating successfully and according to their projections. EOP is an example of a REIT which is more highly sheltered from this kind of eventuality. Its ownership of 114 major commercial office buildings in 47 different markets around the country provides diversification and a consequent spreading of risk. EOP is now in the process of merging Beacon Properties under its name. When completed the REIT will have 240 properties covering 60 million square feet of leasable space. The contrast of the Company with EOP is not entirely fair, because they reside in two different segments of the REIT industry. But it shows the vulnerability of Capital Automotive during its incipient stage when the portfolio is small and the properties are highly localized geographically. Initial portfolio weakness probably is one of the reasons for its low opening stock price of $15. This contrasts with the other 3 REITs, which opened from the low to high $20s. A low opening price forces Capital Automotive to sell more stock in order to get the proceeds it needs. More stock in the market then reduces the earnings per share and finally the size of the dividend for distribution. In Table 3 one can see that the FFO Per Share for the Company is significantly lower than those of the other 3 REITs. FFO (Funds From Operations) often is used by REITs as a more useful measure than earnings for expressing company performance. If lower, we should expect the REIT to show somewhat more moderated growth than the other 3 have experienced. With a lower FFO Per Share the declared distribution also will be lower and the FFO Payout Ratio higher. REITs sometimes boost their payout ratio in excess of 100% in order to establish a more appealing yield to the investor. When this occurs the Company will be paying the difference from cash that could have gone for acquisitions. It might be strategically necessary to boost the yield artificially in this way if by doing so the Company can increase its capitalization. As the Company grows its portfolio, FFO should show a greater than linear increase. When the amount of stock is held constant, FFO Per Share will increase thereby giving the distribution a corresponding lift. Such an increase would have a positive influence on stock price if events were to unfold in this way. In the absence of strength in stock price, the Company must show strength in dividend yield to a level exceeding that of short-term U.S. Government securities to gain the attention of investors. 20% growth by the end of Year 1 would put the stock at $18, or $3 over its opening price of $15. This growth could be motivated by the completion of its acquisitions, thus giving the market the expectation, if not the immediate realization, of stability within the Company, maturity of the portfolio, and an improved yield. Alternatively, without energized portfolio development and continued tepidity in the yield, the stock price will languish with little in the way of upward pressure. The
Financials At $15, market capitalization would reach $225 million. Since current debt is low at $5 million, leverage could bring them as much as $107 million on a 50% of capitalization ratio. Based on the purchase price of the initial set of properties ($116.9 million) the Company could nearly double its portfolio size through the exercise of debt. With $162 million remaining from the distribution it theoretically could triple the size of its portfolio. Whether taking this approach is appropriate or even feasible remains to be seen. However, it does suggest that funds will exist for expansion through the first couple of years. The Underwriter
The
Management |
| Copyright � 1998 Market Analytics | Reproduction of articles or reports is strictly prohibited without written permission from Market Analytics. Opinions expressed in the material are provided as information only. They do not constitute a recommendation to buy or sell any security. |