Liberty Global’s LiLAC Group

Liberty-Global-470x260LiLAC was spun off as a tracking stock from Liberty Global last year. LiLAC is a provider of video, broadband Internet, fixed-line telephone and mobile services. After being spun off, it acquired Cable & Wireless, who owns a combination of cable and mobile assets in the Caribbean. LiLAC previously held large market share in the Chile and Puerto Rico markets and now looks to expand. Liberty Global is looking to acquire an array of cable assets in Latin America as they have done in Europe. With their acquisition of C&W it looks like they are on their way. Creating the LiLAC tracking stock gives management focus as well as a currency with which to potentially execute acquisitions.

Cable & Wireless Acquisition

Prior to being acquired by Liberty, CWC acquired Columbus Networks, a Caribbean cable operator owned by Canadian entrepreneurs and John Malone. Cable & Wireless paid 12.3x EBITDA for Columbus before any synergies. Columbus was growing EBITDA at 15% a year with a presence in predominantly Caribbean countries such as Trinidad, Jamaica, and Barbados. What was interesting about the combination is this would effectively give the combined entity a quad play in many of the countries in which they competed. It is very valuable to be able to have a mobile and fixed infrastructure presence as it reduces churn and creates an incremental, potentially low cost position. When you think about a mobile only player trying to compete against a fixed-mobile operator, the mobile only player should have structurally higher costs as they have to depend on expensive spectrum to transmit data. The combined hybrid player can use a fixed infrastructure presence to offload bits via Wifi at a much lower cost. In markets where the combined Cable & Wireless did not have a fixed infrastructure presence, they have started to selectively deploy the cable infrastructure in these markets being able to leverage the competitive video product. Cable & Wireless has continued the differentiation of their video product through exclusive rights to key sports content such as the Premier League and additional sports and high definition content. When looking at cable assets in the Caribbean region compared to the US or Europe there are a couple of key factors that make the Caribbean substantially more attractive: you have substantially lower penetration of services (around 40% penetration in the Caribbean) providing for a much higher and longer growth runway and the competitive landscape is much more benign especially with broadband given the very limited fiber overbuild. In addition to the consumer platform, the combination of Cable & Wireless and Columbus Networks strengthened the B2B firepower of the combined entity. Given the increased reach of the combined entity into the region as well as critical subsea fiber and backhaul, this combination creates a more compelling telco supplier for enterprises with multiple offices in multiple regions. CWC identified $125 million in synergies from the Columbus Networks combination, Liberty Global believes it can harvest additional synergies both from the Columbus Networks integration as well as from the combination of LiLAC with CWC. Given Liberty Global’s track record in harvesting synergies in previous acquisitions, the subscale nature of LiLAC, and the vast scale of Liberty Global, there should be some level of incremental synergy from items such as the rationalization of overlapping corporate costs and increased purchasing power leading to lower costs. Financially, the combined CWC and Columbus have historically grown revenue high single digits and EBITDA low double digits (not including any synergies). The CWC acquisition gives Liberty Global a significant quad play offering in a growing market. LiLAC is also in good position to acquire assets and continue to consolidate the Latin American market. A potential target would be Millicom. The former head of LiLAC’s Chilean business now runs Millicom. I believe there is a good possibility that John Malone goes after Millicom in the next 12 months.

John Malone

John Malone is a legend in the cable television industry. He became CEO of TCI in 1973 and more recently was CEO of Liberty Media. Liberty Global was spun out of Liberty Media in 2004 and merged with United Globalcom in 2005, shortly after UGC came out of bankruptcy. The company is structured so that Malone has voting control. It has three classes of stock: Class A shares get 1 vote, Class B shares get 10, and Class C shares get none. Malone owns 1% of Class A shares, 85.8% of Class B shares, and 3.5% of Class C shares. John Malone has a terrific track record of allocating capital. I believe the market is discounting the earnings power of the evolving LiLAC Group.

Chile 

The Chile market represents about 28% of LiLAC’s EBITDA. LiLAC’s Chile segment is called VTR. It has been showing very strong growth and has a long runway as penetration remains low.

VTR Growth

VTR’s network is a complete hybrid fiber coaxial network which can attain broadband speeds comparable to high speed cable networks in the US and Europe. They offer speeds up to 160 mb/s. This is much better service than its competitors. Additionally, they offer triple play packages that are far superior.

VTR Bundle

VTR’s biggest competitor is Movistar. As you can see, the pricing for the bundle is about the same but the broadband speed is more than twice as fast. VTR has existing infrastructure that gives them this competitive advantage. As VTR continues to add revenue generating units (RGU), I believe incremental revenues will drop straight to the bottom line.

Chile Broadband Market

VTR Internet

The broadband market in Chile is a duopoly with Movistar and VTR. Combined they have over 75% of the market. We know that VTR is far superior to Movistar. The overall broadband market is growing rapidly with a 12% CAGR over the last decade. VTR has kept its share of the market and has attained double digit broadband growth.

Puerto Rico

Liberty has entered into the Puerto Rico by way of mostly mergers and acquisitions. They are now the largest cable provider in PR. Puerto Rico accounts for about 12% of EBITDA. Similar to Chile, Liberty has key competitive advantages in PR with existing infrastructures allowing them to offer superior services while minimizing costs.

Broadband Market

Lib PR MKT

The broadband market in PR is also a duopoly. However, I believe Liberty has an even bigger advantage against Claro Puerto. Liberty offers speeds up to 200 mb/s where Claro fastest is 20 mb/s. The market continues to grow but not as fast as Chile. The pricing of their broadband has room to move higher. I believe Liberty is focused on stealing more market share from Claro so they can dominate the market. Having access to 80% of the homes in PR gives them a long runway for growth. The fiber deep hybrid-fiber-coaxial cable infrastructure that Liberty has is dominant compared to Claro’s DSL-infrastructure. I don’t see how Claro will be able to compete.

Bundles

Puerto Rico has a very strong bundling rate at 47%. This is the same rate as Chile. The triple play offering in PR outguns Claro or Dish. The broadband is four times as fast and it is priced less than Claro.

PR Bundle

The penetration in Puerto Rico is very low. It is expected to increase 100 basis points each year. This is a terrific opportunity for Liberty. Given that they have a first-class bundle, I expect them to capture the majority of new customers. With limited competition and access to most of the island, Liberty has pricing power. Anyone who wants fast broadband will use Liberty as there is no other option. As the demand for data and streaming increase, broadband will become more important. Liberty’s broadband is 10x faster than Claro’s and this is a long-term advantage.

Economy

It is not a big secret that Puerto Rico’s economy has been struggling. The American territory has stagnated since 2011. The economy has been depending on tourism and even that has now stagnated due to zika concerns. Governor Alejandro Garcia Padilla has said that the debt of PR is now too large to pay. The House of Representatives passed the Puerto Rico Oversight, Management, and Economic Stability Act, a bill meant to help Puerto Rico restructure its debt and prevent the island from being sued for defaulting on bond payments. I believe this will be positive in the long-term. John Malone was well aware of the issues in Puerto Rico when he decided to enter the market. He knew that economic activity might be slow for a period of time. Economic activity is already begin to tick higher now that Congress has passed the law. Puerto Rico has a bright future and as the economy recovers, it will benefit Liberty’s RGU’s.

Demand For High Speed Data

I expect high-single digit residential broadband revenue growth on the back of 1) Increasing broadband penetration from a 40% footprint penetration today, to closer to 50%-60% 5 – 7 years from now, and 2) Mid-single digit growth in data ARPU, driven by a mix-shift towards higher speed tiers and modest inflationary pricing increases. Broadband sells for near 100% incremental EBITDA margins excluding subscriber acquisition costs and is a much more attractive business than video as there are no programming expenses.

The Federal Communications Commission (FCC) actively monitors broadband and video pricing in Puerto Rico. Liberty will have to be careful about price increases in PR because of the FCC. Price increases would also open the door to new competitors. Data usage demand is expected to grow at a 36% CAGR over the next five years. In the last couple years, customers have been demanding more data due to bandwidth-intensive applications. Today there are multiple devices in most homes and we are spending more time on these devices. Demand for streaming HD movies and shows is not going to slow down. It will likely accelerate which will drive customers towards higher priced broadband options like Liberty.

Liberty has acquired terrific businesses in Latin America and the Caribbean. These acquisitions will allow them to scale their business cost effectively and meet demand. Liberty has the only hybrid fiber coaxial network in the markets it competes in. The current DOCSIS 3.0 technology is capable of providing downstream speeds of up to 1 gbps. The fastest speeds they offer today are 200 mb/s which is 10x faster than their competitors. LiLAC can increase broadband speed significantly with minimal costs. The only way their competitors could have similar broadband speeds would be to spend billions on network infrastructure. I do not believe there is a way to do this with a positive ROIC. Google is attempting to do this in the US and it is going horribly. You can read about it here, here, and here. Cable companies like Liberty have a monopoly on high speed broadband. Data can only be transported so fast using wireless technologies. There is major demand for wireless data do to its convenience. However, as more people use wireless data platforms, the traffic slows down the speed of the service. Due to the direction of technological applications, we will see more people turn to high speed broadband over the next decade.

Barriers To Entry

The industry is characterized by increasing barriers to entry. Smaller ISPs can often purchase data capacity from larger ISPs or internet backbone providers at wholesale prices and then sell these services to consumers. This is often the case with smaller companies, which do not have the resources to invest in infrastructure and networks. However, smaller ISPs are usually subject to lower margins and often depend on regulators to set competitive access pricing.

For ISPs that seek to have national coverage and be a major player, barriers to entry can be substantial. As a non-incumbent operator, competitors must either build a copper or fiber network, which is prohibitively expensive for entrants with limited access to capital. Accordingly, most new entrants will invest in “last mile” services, which connect business or residential customers to the internet via a larger ISP or backbone carrier’s infrastructure. On the other hand, new entrants with limited capital are unlikely to succeed in regions without existing network infrastructure.

Risks

The primary risks are related to the Latin American macroeconomic environment and political environment. Currency movements will impact profitability. LiLAC is a levered equity as most Malone businesses are. The cost of capital is relatively high indicating that moderate to accelerated growth is a must. There is a risk that incumbent operators in Chile/Puerto Rico will seek to overbuild Liberty’s infrastructure with fiber which would result in increased competition. However, due to the fact that this option is prohibitively expensive, it is unlikely. Finally, LILAK is a tracking stock, therefore holders will not be legally entitled to the assets associated with the tracker which could lead to a discount to intrinsic value.

Valuation

The valuation of LiLAC looks to be very reasonable. The stock appears to be trading at about 6.8x EBITDA. This is dirt cheap when looking at some of its peers.

LiLAC Estimates

2017 will be the first full year of financials inclusive of the CWC merger. In the years following, I expect a moderate 5-7% revenue growth with EBITDA margins around 45%. Depending on synergies, EBITDA margins could be closer to 46-48%.

LILAK SOTP

Looking at LiLAC another way, I performed a sum-of-the-parts analysis. It appears that the market is undervaluing the business. The long-term competitive advantages of the business provide a terrific moat. As I have mentioned previously, I am not relying heavily on forecasts or valuations. My forecasts are biased and therefore they are often wrong. Valuations are being run on every company by computers everyday with the most accurate information available. The biggest advantage I have is understanding a particular business better than most and focusing on pieces of information being overlooked by the market. In this circumstance, I believe the market is overlooking the value of the existing fiber coaxial infrastructure. Their competitors are at a huge disadvantage and building an infrastructure is not really an option. This should pave the way for solid growth for a long period of time. I have taken a position in LILAK this week under $28 a share. I believe LILAK will outperform the market over the next ten years.

Disclosure


Long LILAK

 

 

 

 

 

 

Wal-Mart Just Declared War On Amazon

amazon-versus-walmart-780x439On January 7th, I posted my first article about Wal-Mart. I posted another on March 23rd. You can read these here and here. Wal-Mart has performed well this year. It is up 19.6% YTD. The market is up 7.1% YTD.

Last week it was announced that Wal-Mart purchased Jet.com for $3.3 billion. What is Jet.com, you ask? It’s a 1-year-old online shopping site selling groceries, furniture, and small appliances. It has some pricing gimmicks, but it’s basically the same old business model: an online marketplace where third-parties source the products and sell directly to consumers.

Wal-Mart’s E-commerce

Wal-Mart’s e-commerce has been a hot topic among analysts for the last 18 months or so. I wrote about their online business in my first two posts. Wal-Mart was expected to spend $1.1 billion this year and $1.3 billion next year on e-commerce. Online sales were expected to grow 20-30% a year which would be consistent with Amazon’s growth. However, last year they fell short of expectations by only growing online sales by 12%. In Q1, they only grew online sales by 7%. Is buying Jet.com the answer? In short, No. I was very supportive of WMT’s e-commerce strategy and investments. I thought they were doing a good job. However, buying Jet.com is a key long-term strategic move for the company and I cannot support it.

Store Productivity

Boosting store productivity of an existing retail store is very difficult. You have to create strategies, goals and initiatives that flow throughout the entire business. Most importantly, the employees that are directly interacting with customers must understand and believe that they are the backbone of the business. No one did this better than Frank Blake at Home Depot in 2010. The company had serious productivity issues and he executed one of the best retail turnarounds ever. (I discussed this in my previous article here.) The reason I mention this again is because we are seeing WMT shift away from these proven strategies. At the beginning of the year, Wal-Mart boosted wages for all employees. This worked very well because it improved customer service and Wal-Mart employees purchased more merchandise when they shopped at Wal-Mart.. The other strategies that WMT put in place were to invest in inventory management systems and close underperforming stores. Both of these were good. Finally, they shifted capex dollars to boost the buyback which has been accretive to shareholder value.

Now they are heading a completely different direction. Instead of focusing on improving the customer experience, they are going after a zero margin business. No one is going to stop shopping on Amazon and start shopping on Jet.com because their dish soap is $0.02 cheaper. That isn’t going to happen. If Wal-Mart tries to cost cut Amazon, they will lose.

Now there are two directions that Wal-Mart can go. 1) Keep Jet.com separate from Wal-Mart.com and try to grow it as fast as possible. 2) Integrate Jet.com into Wal-Mart.com and have a Wal-Mart.com powered by Jet model. I don’t know what they plan to do but either one will cost a lot more than the $3.3 billion they already paid.

Merging Businesses and Cultures

Mergers are extremely difficult. Combining two existing businesses and maximizing synergies is complex and time consuming. It requires excellent planning and perfect execution. The fact is, 83% of mergers fail to increase shareholder returns. Most of the time they don’t work. This acquisition will probably not work out well for existing shareholders. Although $3.3 billion is not a lot of money to Wal-Mart. This is just the beginning. They will probably spend another $3 billion in the next two years merging the businesses.

The capital isn’t the only problem. All companies have limited time and attention. Where they spend that time and attention drives shareholder value. Wal-Mart will be spending an immense amount of time and attention on this merger. Time they could be spending on improving their customer experience. Companies get in trouble when they spend 90% of their time on 10% of the business. This is what WMT is doing and this is a zero margin business. The core business is doing very well posting 1.5% comps and 6.5% comps for neighborhood stores. I fear the company will not appreciate how well this piece of the business doing and not give it enough attention going forward.

Merging Cultures

The Wal-Mart and Jet.com cultures could not be more different. Jet.com has made many moves that sacrifice profit for growth. Wal-Mart is the opposite, they continue to look for ways to boost the bottom line (buybacks, closing stores ect.). Jet.com does not make money and won’t as long as they push for transaction and user growth. Jet.com’s goal is to undercut Amazon’s price which means they are going to have a very difficult time boosting margins. I really don’t know how Wal-Mart will merge these cultures. They are complete opposites.

Current Valuation

Wal-Mart’s valuation does not look as compelling as it did when I posted the article last January. The stock is up about 20% since then so that is part of it. Analyst estimates have slightly fallen in the last eight months. Wal-Mart is expected to make $4.91 in FY2019. We know that historically it has traded with a 15 P/E. This gets us to a valuation of about $73.50 which is where the stock is today. I expect revenue growth to accelerate after the Jet.com deal but I think it will hurt EPS.

The bull case is that the stock will demand a higher valuation with the Jet.com acquistion. I wouldn’t be surprised if the stock does get a higher valuation based off of the deal even though I don’t like it. It wouldn’t shock me if the stock trades at a 17 or 18 P/E which would push the stock closer to $80.

My Portfolio

Wal-Mart is a large position for me. I bought the stock last November and I have done very well with it. However, I want to own great businesses at reasonable prices. A business that is at war with Amazon sounds like a miserable business. I plan on holding Wal-Mart through November for tax purposes. The Jet.com deal will take months to close and I don’t believe the core Wal-Mart business will be affected in the next 12 months. Looking out over the next 10 years, Wal-Mart is going to be in a expensive fight with Amazon.

I currently hold 35% cash in my portfolio. I have only slightly underperformed the market by 28 basis points through July 31st. Owning companies like Wal-Mart (Up 19.6% YTD), Loews (Up 8.4% YTD), Nexpoint Residential (Up 59% YTD), and Post Properties (Up 12.1% YTD) has helped me. Post Properties was purchased last week by Mid-America Apartments for about $72.50 a share. That deal will close in a few months.

There is a good probability that I will sell my Wal-Mart position before the end of the year. This will take me to close to 50% cash. I continue to look for value one company at a time. It is not easy to find great businesses that are trading with reasonable valuations. I am remaining patient and disciplined. Don’t follow the herd. I am prepared to underperform the market in the short term in order to achieve long term outperformance. Charlie Munger says that envy is the worst human emotion. It is 100% destructive. Being envious that others are getting richer faster than you will do nothing for you. When there is an opportunity, I will be ready.

Disclosure


Long WMT

 

 

 

NexPoint Residential – Demographics Driving Growth

Nexpoint480x270

A couple weeks ago, I published a post about Post Properties here. I have received questions about my investment thesis. I explained in the post that I believe the massive amount of student loan debt will delay Millennials purchasing homes for an extended period of time. However, the growing student loan debt is just one macro factor that is driving renter demand. In addition to the student loan debt, there are large demographic shifts happening in the U.S. I believe these shifts will continue and will persist for a very long period of time. Most of this post will cover the demographic shifts that I am seeing. The changes in demographics drew my attention towards apartment real estate investment trusts. I believe NexPoint is in the right market to capitalize on the new environment and will be a great business going forward.

NexPoint Residential Trust, Inc. is a real estate investment trust (REIT). The company is focused on multifamily investments primarily located in the Southeastern and Southwestern U.S. The company’s investment objectives are to maximize the cash flow and value of properties owned, acquire properties with cash flow growth potential, provide quarterly cash distributions and achieve long-term capital appreciation for its stockholders through targeted management and a capex value-add program. The company owns approximately 39 properties representing over 13,000 units in over eight states.

Rental Demand


Today there are 43 million Americans living in rental housing. This is up 9 million people in the last decade. This has been the largest 10 year increase ever. 37% of American’s are now living in rental housing which is the highest proportion since 1964. Many economists have blamed the financial crisis for these statics. However, I believe demographic shifts are having a bigger impact than anyone realizes. The Millennial generation has increased the amount adults in their 20’s. This is the period in life when renting housing is most common. Not only are there a lot of 20 somethings in the U.S, but also, they are getting married and having kids much later than previous generations. Delaying these events is pushing back the point in time when they might purchase a home. The number of renters would actually be higher today if the financial crisis had not happen because it forced many renters to move into their parents/friends houses. Most of these renters are still living with parents/friends. In combination, these trends are showing up in homeownership rates.Homeownership

These trends have boosted the number of renters in all age, income, and household type categories. Interestingly enough, renter demand isn’t as strong from Millennials as you might think. The largest increase over the last ten years was a 4.3 million boost coming from renters in their 50’s and 60’s. Millennials only added 1 million renters. Households 40 and older make up the majority of renters.

Demand for Mid Cost Rentals

There is a huge unmet need in rental housing. Over the last ten years, the supply of mid cost ($400-$800) rentals increased 12%. However, there was a 31% increase in rental households demanding these rentals. From 2001 to 2014, rent prices increased 7% while household incomes fell 9%. These trends have increased the number of cost-burdened (paying more than 30 of income in rent) renters to 49% of the rental population, this is a record. Today 26% of renters are severely burdened (paying more than half of their income in rent.) This is also a record. There is growing evidence that households lacking stable, decent-quality housing are more vulnerable to health problems and developmental delays among children. It is expected that demographics alone will be responsible for an additional 1.3 million renters to be cost burdened over the next decade. This indicates about 55% of rental households will be cost burdened. The unmet demand for mid cost rentals is a large problem.

Growth Demographics

As mentioned, the growth in rental households is not coming from where you might think. Millennials only added 1 million rental households. In the last decade, the number of adults aged 20-29 increased 11%. However, renter households from this age group only increased 2%. This demonstrates the phenomenon of Millennials continuing to live in their parents/friends homes.Demographic Growth

As shown, there was massive growth in rentership from the 30-49 age range.  On net, less than 2 percent of the 30-49 households made the transition from renting to owning over the decade. By comparison, more than 11 percent of baby-boomer households became homeowners when they were at a similar stage of life in 1984–1994. The largest increase in rental household came from baby boomers at 4.3 million driven by the decrease in homeownership. These large rentership rates from baby boomers are likely to persist. As people age, the probability of them making the rent-to-own transition decreases while the probability of own-to-rent increases. As more baby boomers make the own-to-rent transition, the unmet demand for rental housing could grow even further.

Forecast of Future Demand

Demand going forward is expected to be strong. Half of the Millennial generation are still in their teens and many will become renters in the next ten years. It is projected that 12 million millennials will be added to the rental population over the next ten years.

Another trend that will boost rental demand is strong immigration. Minorities are expected to account for three quarters of household growth over the next decade. There is a large gap between white and minority ownership rates. The probability of minorities renting is much higher. Therefore, strong immigration will translate into more demand for rental housing.

The other trend that we will likely see is the continuation of the own-to-rent transition from baby boomers. As many will reach 70 in the next ten years, many will transition to renting. This will accommodate their need for accessibility. I expect this transition to keep pressure on homeownership rates over the next ten years.

Rental Supply


There is currently a large lack of supply of low and mid cost apartments. Historically, newer apartments would age and the rent would filter down to supply the low and mid cost markets. However, there has not been enough apartments filter down into these cost markets to satisfy demand.

Costs of Development

Developers face a variety of regulatory and financing obstacles that limit their ability to add significantly to the lower-mid cost stock. Local zoning regulations often restrict the area available for multifamily development, especially in suburbs, which can increase the competition for available sites and raise land costs. Many regulations and zoning reviews are resulting in per-unit construction cost increases. It has made it almost impossible to build a new multifamily apartment complex that the median renter ($875) can afford. Most developers are focused on the upper end of the market which is causing the gap between supply and demand of low-mid cost rental housing to get wider.

Long-Term Supply Issue

Today 80% of newly constructed rentals are multifamily apartment buildings with 50 or more units. The median cost of these apartments is $1290 which does nothing to address the problem. This means that downward filtering of higher cost rentals will have to account for the supply of mid-low cost rentals. In the last decade, downward filtering boosted supply by 11%. The only problem is, because mid-low cost units are older, all of these gains were offset by rentals that were permanently removed from the supply because they had to be demolished. Therefore, only 8% were added in the below $400 range and there was just a 12% increase to the $400-$800 range. A 12% increase does almost nothing when there is 31% increase in demand for rentals in the $400-$800 range. This problem continues to get worse.

Market Conditions


Since 2011, rents have increased at an average pace of 2.7% a year. However, in the last 12 months they increased at a faster 3.6%. With overall inflation at just 0.4 percent, the real increase in rents in the preceding 24 months was larger than in any other two year period since 1987.

Rent

Vacancy 

The national vacancy rate sits at 6.7% its lowest rate in 30 years.

Vacancy

In the last five years, there has been a 1 million unit reduction in vacancy. Over 750,000 of the million were units priced below $800. Today, vacancy rates of units priced below $800 is only 3.9%. This is the lowest it has ever been. You should expect continued pressure on rising rent and falling vacancy rates in the coming years. Much of the future growth will be from minorities and senior households who typically have lower incomes.

NexPoint Residential


NexPoint owns multifamily properties in the Southeastern and Southwestern U.S. The great part is they offer Class B apartments in the $500-900 range. Right where the demand is greatest.

Organic Growth

NXRT has shown many quarters in a row with exceptional organic growth. The growth is driven by their rehab capex spending and the strong rental market. They are on pace to have about $30 million in capex for 2016. As of Q2’16, they have about $42 million in-progress rehab projects. Over the last four quarters, NXRT has achieved 12.2% same store NOI growth. This is double its peer average at 6%. Thier occupancy rate also outperforms peers at 94.8% vs. 94% for peers.

The company has averaged a capex ROIC of 21.2%. Assuming this continues into 2017, investors can expect $5.8 million in incremental NOI. This translates into $0.28 in FFO bringing estimated FFO to $1.73 for FY’17. At $1.73, NXRT only trades at about 11x FFO. Its peers trade closer to 17x.

Management

The management group has done very well and they have a lot of skin in the game. All of the top direct holders are in the management group. Combined they hold 4.25 million shares or 20% of the company. James Dondero is the President of NexPoint Residential. He is also Co-Founder and President of Highland Capital Management. On top of the 20% owned by management, Highland Capital owns 1.65 million shares or 8.22% of the company. All together, between management and Highland, they own 28% of NXRT and continue to buy more.

Financial Overview

NXRT Financials

Summary

NexPoint is a very underfollowed company that trades at a very reasonable valuation. The metric worth paying attention to is Funds from Operations (FFO). This is calculated as net income available to common shareholders determined in accordance with GAAP, excluding gains (or losses) from extraordinary items and sales of depreciable property, plus depreciation of real estate assets, and after adjustment for unconsolidated partnerships and joint ventures all determined on a consistent basis in accordance with GAAP.

Returning Cash to Shareholders

NXRT has a nice 4.29% dividend yield. This is the lowest it has yielded since the stock became public so I wouldn’t be surprised if they decide to raise it in the next few quarters.

Debt

The balance sheet is quite levered. The debt/equity ratio is about 3x. However, they are becoming less levered every quarter and I don’t see any reason why this trend won’t continue with the demand I see.

NXRT Debt

This chart above shows how different NXRT’s business is from other REIT’s. They have more debt than their peers but their debt agreements are much more favorable because they are variable. With interest rates continuing to stay low, they are not having to pay much interest on their debt. Monetary policy from the Fed will have a large impact on the cash flow of the business. We know the Fed wants to raise interest rates and I believe there is a good chance they will in September if they economic data remains decent. On June 6th, NXRT entered into a credit facility of $200M with terms 1 month LIBOR + 2.2%. Today, they have $258M in variable rate debt. Even if they Fed raises rates, LIBOR will likely not be greatly affected. Bottom line is, if interest rates in the U.S rise quickly, their debt agreements could swing from being a tailwind to a headwind. I cannot predict where interest rates are going. I have no idea and I am not going to waste my time trying to guess. Therefore, I will monitor relevant interest rates but focus on their business.

Valuation

NXRT valuation

I am trying to get away from doing rigid valuations. Investing is an art not a science. I just put this one together quickly. I don’t want to put much emphasis on it. It does indicate that there is value in the stock even if it grows at 3% a year. NXRT is growing at 20% so far in 2016. I believe NXRT can grow at 10% or more a year for many years considering the demand for apartments they offer.

Each quarter, management includes a NAV calculation in their financial supplement. Below is the NAV calculation from Q2.NXRT NAV

If you look towards the bottom right you can see the est. NAV is between $19.44 and $24.78. The midpoint is $22.11 or 12.8% above current market prices. I find it hard to believe that NXRT continues to trade at a large discount to NAV. I believe this is an opportunity for investors.

Bottom Line

NexPoint is a terrific business. Demand for their units is incredible. It could take decades before today’s Class A apartments filter down to satisfy demand. I believe we are going to continue to see NexPoint acquire properties and grow NOI. Management owns 20% of the shares giving them plenty of incentive to perform. I look forward to watching this company grow in the future.

Disclosure


Long NXRT

 

 

 

 

Tailored Brands Inc. – Game Of Loans

People pass by a Men's Wearhouse store in New York June 25, 2013. Men's Wearhouse Inc said it fired founder and Executive Chairman George Zimmer after he pushed to take the company private and effectively demanded to be reinstated as the sole decision maker at the clothing chain. REUTERS/Brendan McDermid (UNITED STATES - Tags: BUSINESS TEXTILE LOGO)

Tailored Brands, Inc. is the old Men’s Wearhouse. The company is an apparel retailer offering suits, suit separates, sport coats, slacks, business casual, sportswear, outerwear, dress shirts, shoes and accessories for men and tuxedo and suit rentals. It operates through two segments: Retail and Corporate Apparel. The Retail segment includes over four retail merchandising brands: Men’s Wearhouse/Men’s Wearhouse and Tux, Jos. A. Bank, Moores, and K&G. Specialty apparel merchandise offered by its retail merchandising concepts include suits, suit separates, sport coats, business casual, sportswear, outerwear, dress shirts, shoes and accessories for men. Women’s career apparel, sportswear and accessories, such as shoes and children’s apparel, are offered at its K&G stores. The Corporate Apparel segment includes corporate apparel and uniform operations conducted by Twin Hill in the United States and Dimensions, Alexandra and Yaffy in the United Kingdom. The company recently signed a large deal with American Airlines to provide all uniforms for employees.

Company History


The first Men’s Wearhouse was opened in Houston, TX in 1973 by George Zimmer and his roommates. Beginning in 1986, Zimmer began appearing in commercials that closed with the company slogan “You’re going to like the way you look. I guarantee it.” Zimmer and his friends grew the brand in the U.S and Canada to over 700 stores before he was fired as Chairman and CEO on June 19, 2013. Zimmer had expressed concerns to the Board about the strategic direction of the company. He wanted more control and it eventually led to his termination. In 2014, Men’s Wearhouse acquired Jos. A. Bank for $1.8B financed by debt. The stock is down more than 75% since the acquisition creating a possible opportunity for investors.

Jos. A. Bank Acquisition


This acquisition was terrible. Just awful. They paid way too much for a deteriorating business. The acquisition price was pushed higher because Eddie Bauer was also trying to purchase Jos. A. Bank (They really dodged a bullet on that one.) I have tried to get my hands on the merger agreement but had no luck. I am really curious as to why they did not have a post-acquisition performance covenant. When I was in graduate school, I was taught to always include this in a deal even if the benchmarks seem easily achievable. Having this earnout covenant would have saved them. The business was deteriorating when they bought it. Most companies want to protect themselves with multi-year post-acquisition performance measures so things like this don’t happen. Not having it has been disastrous to the stock price.

Although the deal was terrible for existing shareholders I believe there is value in the stock today. In 2015, Tailored Brands wrote off $1.24B of goodwill from the acquisition. They paid $1.8B. This would mean that they only received $560 million of value. I don’t believe the deal was that bad. Below is a screenshot of Jos. A. Bank’s balance sheet before the acquisition. Jos BS

Prior to the acquisition, Jos. A. Bank had $935M in assets and only $200M in liabilities. To be conservative, I would write off half of the acquired inventory since we know business has been bad. After that write off, I calculate that $585 million in assets were acquired (935-200-150=585). So we know they acquired about $585 million in assets vs. the $560 on the balance sheet today. This would mean that TLRD’s financials indicate the actual business of Jos. A. Bank is worthless and there were no synergies. We know this isn’t the case. Comp store sales at Jos. have taken a hit but are beginning to recover.

So how did this happen? After TLRD acquired the company, they realized that the business had been deteriorating for some time. As most know, Jos. A. Bank was famous for their buy 1 get 3 free marketing strategy. TLRD realized that this strategy does not breed repeat business. Customers go buy four suits then don’t go back because they don’t need four more. Once they have a few suits, they buy one at a time. TLRD management decided to change the company strategy and get rid of the buy 1 get 3 free strategy. If they paid attention to what Ron Johnson did at JCP, they had to have known that comps would tank. When customers are trained to receive discounts and the discounts stop, they stop going. The good news is the customer satisfaction of customers shopping at Jos. have improved indicating management has infused the stores with the customer service that Men’s Wearhouse is known for.

Debt Situation


To close the Jos. A. Bank deal, they entered into several debt agreements. Below is a summary of the agreements:

  • $1.1B Term Loan due June 2021. Terms: LIBOR + 3.5%
  • $500M ABL Facility loan due 2019. Terms: LIBOR (No borrowings as of 4/30/16)
  • $600M in 7% Senior Notes due 2022.

As of 4/30/16, TLRD had $1.65B in long-term debt. $1.1B is due in 2021 and $600M is due in 2022. I believe that comps are beginning to turn around but I don’t think the company will be able to retire all of its debt on time. This leaves them with a few different options. 1) Cut the 5% dividend 2) Secondary equity offering 3) Refinance the debt 4) Use the ABL facility loan to make principal payments. The company does not seem to be worried about liquidity issues. It appears that they are going to go with option 4 if need be. They seem very optimistic about the turnaround at Jos. A. Bank so they might start generating solid FCF in 2017.

Competitive Advantages


The Men’s Wearhouse brand is very strong. Additionally, online retailers like Amazon are not going to be able to cut into their sales. Men and women are still going to need to get fitted for suits. While they are there, they will buy ties and other accessories. Many of TRLD’s competitors are struggling to compete with Amazon and are seeing slowing traffic. Some of their largest competitors include Macys, Kohls, JCP, Dillards, and Nordstrom. All of these competitors are struggling to find ways to get customers in their stores. As traffic continues to slow in these stores, we will likely see their market share of formal men’s clothing decrease which will benefit Tailored Brands.

The best thing about shopping in Men’s Wearhouse is the customer service. The sales people are promoted to encourage customer satisfaction and loyalty. They are not paid on commission so you don’t get the car salesman experience. The company has a deep breadth of merchandise with a broad assortment of styles. With a nice breadth of products and high customer service, they are able to achieve repeat business.

The Path Ahead


Management has outlined a profit improvement program that is currently being executed. They will close 250 stores across the portfolio in 2016. The breakdown is 90 Jos. A. Bank, 58 outlet stores of MW and Jos., and 110 MW Tux stores as a result from their partnership with Macy’s. The Jos. A Bank stores that are closing are located in saturated markets and are underperforming. All outlet stores are closing because there was not enough differentiation between the full line stores and the outlets, and they don’t make money when you factor in the central overhead. I don’t like brands that have outlets because I believe it damages the brand with cheaper clothes, so I am all for this.

Management has already recognized about $100 million in synergies from the Jos. A. Bank acquisition even with the decline in comps. They remain very optimistic that the brand will return to solid positive comps in 2017. The comps at Jos. A. Bank appear to have bottomed and management certainly thinks the worst is over.

Jos Comps

The overlap between MW and Jos. A Bank customers is very low at about 7%. The Jos. A. Bank customer is older, more affluent, and prefers a traditional style. The MW customer is younger and shops for more trendy styles. Research conducted from management says 85% of customers plan to shop at Tailored Brand stores again.

One of the bright spots from the Jos. A. Bank acquisition was the Joseph Abboud brand. This is an exclusive line of clothes sold by MW that has had tremendous comps over the last year. This spring, they launched the Reserve designed by Joseph Abboud and it has done very well. Management expects this line of clothes to continue to grow.

TLRD management wrote off all of the goodwill ($769M) from the acquisition and ($426M) in tradename impairment. Today they have $113M left in tradename carrying value related to Jos. A. Bank.

Valuation


There are a few ways to look at the valuation. The stock is down 75% since the Jos. A. Bank acquisition even though it is only 25% of the overall business. The MW, K&G, and Moores stores are doing quite well. We know that TRLD acquired roughly $585 million in hard assets from the Jos. A. Bank transaction. In addition, they still have $113 million in tradename carrying value and they have achieved about $100 million in synergies. Prior to the acquisition, Men’s Wearhouse, K&G, and Moores had a combined market value ranging from $2.1B-$2.8B. These brands have all done well since the merger.

Jos SOTP

Prior to the merger, MW had a base market value of about $2.4B. If we assume Jos. A. Bank is worth nothing and deduct today’s debt you get to a market value of about $750 million which is today’s market cap. The market is throwing in Jos. A. Bank for free. Management is very optimistic that Jos. A. Bank will have a solid 2017. I believe Jos. A. Bank is worth $600 million today meaning the stock is worth about $27. This represents about 90% upside.

Disclosure


 

Long TLRD

Post Properties – Millennials Driving Steady Growth

Post HeadlinePost Properties, Inc. is a self-administrated and self-managed equity real estate investment trust (REIT). The company’s segments include Fully stabilized (same store) communities, which includes apartment communities that have been stabilized for both the current and prior year; Newly stabilized communities, which includes communities that reached stabilized occupancy in the prior year; Lease-up communities, which includes communities that are under development, rehabilitation and in lease-up but were not stabilized by the beginning of the current year, including communities that stabilized during the current year; Acquired communities, which include communities acquired in the current or prior year, and Held for sale and sold communities, which include apartment and mixed-use communities classified as held for sale or sold. Its operating divisions include Post Apartment Management, Post Construction and Property Services, Post Investment Group and Post Corporate Services.

Management


The management team of Post is terrific. They are very patient in acquiring land to ensure their moves are accretive to shareholders. Once land is acquired, it is developed quickly into high quality, well appointed communities. As communities mature, Post periodically sells communities when valuations are full and redeploys capital into new opportunities. Management has a great track record of returning cash to shareholders and has continued to do this consistently. Post recently announced they have signed a joint venture agreement with a Denver based builder that paves the way for Post to re-enter the Denver market. They sold their last community in Denver in 2007. Pretty good timing.

When Post looks for opportunistic markets, a key attribute they look for is above average job growth. Management has been very selective in entering new markets. The brand is established in existing markets and renters know the apartments are fairly priced. Entering new markets requires Post to spend money to establish the brand. Management believes that there is a terrific opportunity to re-enter the Denver market and do very well.

Portfolio


Post holds a very strong portfolio of communities. Thier two largest markets are located in Atlanta and Dallas. Each of these respective economies have had strong rent occupancy rates. A screenshot of Posts entire portfolio is below.

Post Communities

The only market that hasn’t been strong in the last year is Houston due to the dip in oil prices. However, oil prices have stabilized and Post is seeing improvement. All of the other markets have been very strong with solid renewal rates.

Dispositions


Equity REIT’s require a bit of extra thought from potential investors. I believe that Post has one of the best real estate portfolios in the business. They have historically done very well in their dispositions which has allowed them to reinvest in new opportunities. Below is a screenshot of dispositions.


Post Dispositions

It is very common for Post to sell their communities with large gains due to depreciation rules set by the Financial Accounting Standards Board (FASB). Post depreciates its properties on a straight-line basis over 40 years. However, it is common that real estate prices will rise over time creating a large variance between book and market values. Because of Post’s terrific real estate portfolio, I believe they are accumulating large gains on top of the growing rent cash flows.

Funds From Operations


The metric that I am using to value Post is Funds from Operations (FFO). This metric was created by the National Association of Real Estate Investment Trusts (“NAREIT”). It is defined as net income available to common shareholders determined in accordance with GAAP, excluding gains (or losses) from extraordinary items and sales of depreciable property, plus depreciation of real estate assets, and after adjustment for unconsolidated partnerships and joint ventures all determined on a consistent basis in accordance with GAAP. Below is Post’s FFO.

Post FFO

I expect Post to earn $3.25 in FFO in 2017 which prices the stock at about 19x forward FFO and this excludes gains on deprecated communities. I think the hidden value in the stock are these gains that are accumulating. I don’t expect large rent growth over the next ten years but I do believe the value of their portfolio will continue to grow and appreciate.

Millennials


The Post brand holds value with Millennials. Post apartments are seen as hip and they have great locations. Post is in a secular market that is being driven by the massive amount of student debt.

Student Loan Debt

There is currently $1.3 trillion in student loan debt and it continues to grow. It is projected there will be $15 trillion by 2030. We are in a new environment where Millennials want luxury accommodations but most can not afford to own a new luxury home. Instead, they are going to rent nice apartments from companies like Post Properties. It will take years for the mid to late Millennials to get out from their student loans and be in a position to own a new home. In addition, this isn’t just going to be a trend with Millennials. Generation Z will have this same problem. Actually, it could take Gen Z longer to get rid of their student loans which means they will have to postpone purchasing their dream house for even longer.

I believe the large amount of student debt is driving the demand for apartments. However, there is a theory that Millennials are adverse to making large purchases and enjoy moving around. Research indicates that Millennials move around more than prior generations. We just don’t know what is driving this behavior. If Millennials could purchase houses, would they do it and stop moving around? Who knows, but it doesn’t matter. We know that Millennials are soaked in debt and they are moving around. This is a good environment for Post.

Financial Overview


Post Financial Overview

The financial overview of Post is pretty simple. As mentioned, the way that I value the company is using the FFO. Historically, the stock has traded with a FFO between 16 and 22. Today we are right in the middle at 19. I believe that this is a fair price to pay considering the environment we are in. After all, the 10 year yield is hovering around 1.55% and Post yields a healthy 3% dividend.

Bottom Line


 

Post Properties has an extraordinary portfolio of properties. These properties have exceptional locations and are seen as hip to Millennials. The amount of debt that is weighing on the Millennial generation is not going away. I believe that we are going to continue to see strong demand for luxury apartments be driven by student loan debt. Post is a growing business with a nice yield and has phenomenal management. I think investors have a lot to look forward to.

Disclosure


Long PPS