Barbarians at the REIT?
What is my hand worth?
As reported in the Wall Street Journal (subscription required):
Expectations were building last night that rival bidders might soon materialize to challenge the $20 billion buyout of Equity Office Properties Trust by Blackstone Group.
Equity is potentially a tasty and large dish, for the Blackstone offer was only a modest premium above its trading price:
Blackstone’s offer [$48.50 per share — Ed.] was an 8.5% premium to the price of EOP’s closing price on the day prior to the merger announcement on Nov. 20. And Blackstone’s price was a 7.2% premium over Equity Office’s net asset value of $45.25 per share estimated by Green Street Advisors, a
Because it has location-specific features, real estate is a very tough asset for publicly traded entities to own. As I posted a month ago:
I have no idea whether Equity Office is properly valued or undervalued. Real estate, the ultimate long-term asset, is often mis-priced in publicly traded vehicles, even REITs, whose focus is short-term.
Yet if an asset cannot reach the public markets, it is deprived of access to an enormous pool of investors, so it trades at a discount.
Do you value my market cap, boys?
Hence the emergence of REITs, not so much as a speculative or trading vehicle, but as buy-and-hold income producers:
Because they combine tax efficiency (tax transparency and avoidance of double taxation) and liquidity (freely tradable and publicly listed), REITs have long appeared the optimal large-holding vehicle for income-producing property.
What then is the value of real estate held in a public company? There are three main methods of estimating:
- Market cap. Aggregate value of all the shares outstanding. Often described as “what Wall Street thinks the company is worth.”
- Implied property value. Many firms estimate Net Asset Value — in essence, what the property would be worth if everything were sold.
We’re just trying to get net asset value.
- Capitalized income. Some analysts try to ‘look through’ the ownership entity to the properties themselves, and compare the implied market cap with the aggregate Net Operating Income.
As the Journal describes it:
Measured by current rental income, Blackstone’s offer for the country’s largest office-building owner and manager is already richly valued at some $36 billion, a figure that includes $16 billion of debt. But by at least one other important measure — the price needed to replace the buildings in Equity Office’s portfolio — the deal doesn’t look impossible to top.
Three barriers stand in the way of potential suitors: bulk, speed, and management. Let’s start with bulk, recognizing that Blackstone’s group bid $48.50 per share:
Until the past few days analysts were unsure whether any bidders would be willing to go above the $49.50 per share needed to top Blackstone’s price and cover the termination fee.
“Termination fee”?
You vill pay me too hundret million
Equity Offices’ proxy filed to the Securities and Exchange Commission on Dec. 14 stated that Blackstone originally wanted a termination fee of $275 million, which was negotiated down to $200 million. Green Street Advisors described the termination fee as “modestly lower than we would have expected” and pointed out that in another recent deal involving another REIT, SL Green Realty Corp., the fee was about 3% of the initial value.
It’s quite understandable that a big entity like Blackstone, which puts a great deal of effort into preparing a credible bid, would want reasons to be confident that the transaction would proceed. Hence provisions like this:
Samuel Zell, Equity Office’s founder and chairman, said in a previous interview with the Journal that it agreed in its negotiations with Blackstone not to seek competing bids. But he said a process was in place for the board to consider unsolicited offers.
Even as they might allow Blackstone an exclusive negotiation interval, neither Mr. Zell nor any other board member with an ounce of fiduciary responsibility would be able to reject out of hand any other applicant. But they could agree, as they did, to recompense the suitor if, contrary to their expectations, the fair maiden shareholders rejected their wooing.
“Who chooseth me shall gain what many men desire“
Once the Merchant of Venice’s bride is in play, she’s fair game for anybody:
So far, buyout firms have observed an unstated gentleman’s agreement not to top, or “jump” in Wall Street parlance, signed merger deals. But real-estate firms aren’t party to that understanding.
Particularly when the maiden herself seems so delectable:
The interest comes at a time when the debt markets are happy to throw money at mega deals.
We saw the same hyperventilating capital markets in Stuyvesant Town, which sold above the asking price, and we saw the same dynamics, a seller trying to keep out distractions by moving quickly:
One major impediment to a rival bid are the matching rights enjoyed by Blackstone that allow the firm to match any price offered by a rival. A rival would also be under time pressure, given that the Blackstone deal is expected to close within three weeks.
As in Stuyvesant Town, the proponents are using speed as part of their strategy:
Barrow favored Fords for their speed
Going back to that termination fee, Blackstone bid $48.50. With 351 million shares outstanding, the uptick required is about 65 cents a share (plus costs), or a little more than 1% over Blackstone’s bid. It’s certainly plausible:
Top real-estate and private-equity investors were buzzing that a competing offer could come within a matter of days, possibly from an investment team led by real-estate maven Barry Sternlicht of Starwood Capital Group Global LLC and Neil Bluhm of Walton Street Capital. The two were seriously considering an offer last night [
If you want the maiden’s hand, bring your dowry:
The two still haven’t completed financing for an offer.
One possible funding source could be Cerberus Capital Management, a New York-based financial conglomerate, people familiar with the matter said.
Things are worth what they can be financed for, and as interest rates drop, market capitalizations rise:
Borrowers have been able to attract capital at cheap rates, and what they can borrow as a percentage of the total value of assets is also high. Moreover, any buyer would likely split off some of the trophy assets to help pay for the deal — part of Blackstone’s plan.
Public markets, however sophisticated they may be about earnings and growth, are notoriously insensitive to quality differences in their hard assets. If Equity Office has a few very trophy properties whose value is greater than their current earnings multiple — maybe because they’re scarce, or could convert to another use, or simply are in a white-hot local market — those are valued at the same homogenous multiple as the most vanilla office park in suburbia. Popping them out of the newly privatized entity will generate extra cash, pay down the denominator, and increase the equity bang available to the buyers. The financial analysis is highly complex.
“Who chooseth me shall get as much as he deserves.”
A competing bid would set off what would be the most high-stakes and high-profile bidding war since the contest for RJR Nabisco nearly two decades ago. And it would be a potent indicator of the intensity of the competitive rivalry to buy companies.
If you who haven’t seen it, you must rent Barbarians at the Gate, the deliciously cut-throat movie of the KKR/ RJR Nabisco leveraged buyout fight. From Jonathan Pryce’s surgical Henry Kravis to James Garner’s aw-shucks tobacco shark Ross Johnson, everyone involved is portrayed with rococo zeal.
Luck is the lady that he loves the best
Will the newly privatized Equity Office be gold, silver, or lead? The Prince of Morocco, who chose the golden casket, read this scroll:
All that glitters is not gold;
Often have you heard that told:
Many a man his life hath sold
But my outside to behold:
The winner will be he who has the most economic courage:
Who chooseth me must give and hazard all he hath.
