Colony Capital, Inc.
Q2 2019 Earnings Call Transcript

Published: 9 Aug 2019

[Operator:]

Greetings and welcome to Colony Capital Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.I would now like to turn the conference over to your host, Lasse Glassen with ADDO Investor Relations. Thank you. You may begin.

[Lasse Glassen:]

Good morning, everyone and welcome to Colony Capital Inc.'s second quarter 2019 earnings conference call. Speaking on the call today from the company is; Tom Barrack, Chairman and CEO; and Mark Hedstrom, COO and CFO; Darren Tangen, the Company's President; and Neale Redington, Chief Accounting Officer will also be available for the question-and-answer session.Before I hand the call over to them, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties and assumptions. Potential risks and uncertainties that could cause the business and financial results to differ materially from these forward-looking statements are described in the company's periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, August 9, 2019, and Colony Capital does not intend and undertakes no duty to update for future events or circumstances.In addition, certain of the financial information presented in this call represents non-GAAP financial measures, reported on both a consolidated and segmented basis. The company's earnings release, which was issued this morning and is available in the company's website, presents reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors.In addition, the company has prepared a table that reconcile certain non-GAAP financial measures to the appropriate GAAP measure by reportable segment and this reconciliation is also available on the company's website.And now, I'd like to turn the call over to Tom Barrack, Chairman and CEO of Colony Capital. Tom?

[Tom Barrack:]

Good morning and thank you, Lasse. During the Colony Capital fourth quarter earnings call in the spring of 2018 as Executive Chairman, I outlined a series of near-term objectives, which we would undertake. These objectives were

[Mark Hedstrom:]

Thank you, Tom and good morning, everyone. As a reminder in addition to the release of our second quarter earnings, we filed a corporate overview and supplemental financial report this morning. Both of these documents are available within the public shareholder section of our website.On the call today, I will provide a review of second quarter results, business segment performance, status of our cost reduction initiatives and several important transactions which occurred during and just after the end of the quarter.Turning to our financial results for the second quarter. GAAP net loss attributable to common stockholders in the second quarter was $469 million or $0.98 per share, largely a result of impairments and provisions for loan losses totaling $353 million for the company share.That amount included a $228 million non-cash GAAP accounting write-down of the carrying value of the company's 48 million common share interest in CLNC to a value based on CLNC's closing stock price of $15.50 on June 28, the last trading day of the second quarter. While we continue to believe strongly in the long-term value of CLNC shares, we made this accounting write-down due to uncertainty over the timing of recovery of CLNC stock price in the near term.Core FFO in the second quarter, was $57 million or $0.11 per share. Excluding net investment losses of $17 million, core FFO would have been $74 million or $0.14 per share.Approximately, one-third of our net investment losses related to our share of investment losses, realized by CLNC during the quarter, with the remainder related primarily to losses on sales of. And loan loss provisions on Other Equity and Debt investments, most of which we had planned for as part of our strategic monetization program.During the second quarter, we made significant progress towards our strategic objectives, which Tom just discussed. And we also had a strong operational quarter across most of our existing, six reportable business segments, as well as continued positive progress against our cost reduction initiatives.Starting with the Healthcare Real Estate segment, same-store portfolio NOI increased, 1% compared to first quarter 2019. On the financing front, we refinanced on very favorable terms, $1.7 billion in health care debt which was scheduled to mature, in December 2019.We contributed $175 million of equity, primarily to reduce the loan balance. And we expect that amount to decrease to approximately $90 million, on a net basis following the sale of certain assets that were previously encumbered, by the original debt, and are presently under contract to be sold.This refinancing along with previously completed refinancing transactions earlier this year, addresses four of the six health care loans maturing in 2019 or 87% of the consolidated outstanding principal balances.The remaining two health care, loans are expected to be refinanced or repaid by year-end. And with these health care maturities addressed, we can dedicate our focus, entirely to operations and strategy to maximize value within our portfolio.Turning to the Industrial Real Estate segment, Light Industrial same-store portfolio NOI increased, 1% compared to first quarter 2019, primarily due to an increase in rental revenue partially offset by higher repair and maintenance costs.As part of our ongoing strategic review, the company engaged advisers to market its industrial portfolio for sale, resulting in a change in accounting presentation in our quarterly financial reporting.Accordingly, for the second quarter, and all prior periods presented, the related industrial segment assets and liabilities were reclassified as assets and liabilities, held for sale, on the consolidated balance sheet.And the related operating results, from all items of income and expense, are reported in a single line item as income from discontinued operations, on the consolidated statement of operations.We hope to be in a position to provide additional information, on the results of the sale process, next quarter. Moving on to the Hospitality Real Estate segment, compared to the same period last year, second quarter 2019 same-store portfolio NOI before FF&E reserves, decreased 3%, primarily due to a combination of weaker corporate travel demand, the presence of new supply in certain markets and increased labor and property tax expenses.We continue to call lower quality assets in this segment. And we are also in the process of refinancing debt related to a couple of our portfolios, to provide more term at more attractive interest rates. Yesterday, CLNC reported, second quarter core earnings of $36 million or $0.28 per share, compared to core earnings of $12 million or $0.09 per share in the first quarter of 2019.These core earnings included, realized net losses in the second quarter of which our 36% share was $5 million. These losses resulted from the foreclosure of a loan collateralized by a U.S. retail property. As a reminder, this loss was anticipated in the fourth quarter of 2018, when CLNC had recorded a related loan loss provision, in their GAAP earnings.Adjusting for this anticipated foreclosure event, CLNC's core earnings, would have been $0.39 per share in the second quarter. Next is our Other Equity and Debt or OED segment, a $1.8 billion equity value portfolio separated into strategic OED and nonstrategic OED.Strategic OED includes our investments alongside third-party capital, where we earn Investment Management economics, and which we plan to grow over time. During the second quarter, the underappreciated carrying value in strategic OED decreased by 2%.Additionally, subsequent to the end of the second quarter, NorthStar Realty Europe or NRE, which we manage and which we have an 11% equity stake, entered into a definitive agreement to be acquired for an estimated $17.03 per share.Upon closing, which we anticipate to be around September 30 2019, assuming receipt of shareholder approval, the company is expected to receive proceeds of approximately $96 million, for its 11% equity interest in NRE, and approximately $65 million for the termination of its management agreement.We are also actively managing and liquidating nonstrategic OED, which includes legacy investments that are at the end of their investment life and/or are not in line with our strategic Investment Management strategy. During the second quarter, underappreciated equity carrying value in non-strategic OED declined by $124 million or 11% from $1.1 billion to $1 billion.Our investment management business segment continues to increase in its significance as a strategic component of overall revenues and operations of the company.Colony ended the second quarter with third-party AUM of $28.6 billion compared to $28.8 billion last quarter and fee-earning equity under management up slightly to $18 billion compared to $17.8 billion last quarter. The increase in fee-earning equity under management was primarily attributable to the acquisition of the Latin American investment management arm of Abraaj Holdings, now called Colony Latam Partners which was partially offset by the sale of a noncore real estate investment management business and other asset sales.We opened several new international offices during the second quarter to support investment management growth including a Singapore office which will serve as another base for future capital raising in Asia as well as offices in Mexico City and Lima, Peru both of which support the operations of Colony Latam Partners.Tom discussed the exciting recent developments in our investment management business subsequent to the end of the second quarter including the acquisition of Digital Bridge Holdings the growth of our energy platform and the first closing of Colony's fifth global real estate credit fund.Together with planned sales of certain assets and business units, this is anticipated to be a transformative year for Colony as we continue to execute on our strategic plan to focus resources on high-growth and less capital-intensive investment management businesses.Finally, I will provide an update on the corporate restructuring and reorganization plan announced during the fourth quarter of 2018. During its first eight months since implementation, the company has achieved approximately two-thirds of the expected $50 million to $55 million cost savings on a run-rate basis through various initiatives including the reduction of more than 10% of the company's workforce existing at the time the restructuring was announced.We expect to meet or exceed the original cost savings targets over the coming six to nine months. In addition to cost reductions including those related to the anticipated sale of assets we are also continuing to drive non-compensation-related administrative cost savings and efficiencies through expense policy changes by leveraging of technology and the utilization of offshore resources where possible.In summary, we are very pleased with our strategic progress and operating results during the first half of 2019 and we remain focused on achieving our full year goals and objectives during the second half of 2019.With that, I'd like to turn the call over to the operator to begin Q&A. Operator?

[Operator:]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Randy Binner with B. Riley. Please proceed with your question.

[Ryan Aceto:]

Good morning everyone. This is actually Ryan Aceto on for Randy. Turning to the industrial portfolio, press release is a little vague. Are you looking to sell the entire portfolio or just the light section of it?

[Tom Barrack:]

Ryan it's Tom. What we did is actually asked for the best initiative and inform of a request for proposals for all of it. So, you could bid on the manager, you can bid on the assets, you can bid on both. And we'll see in the next 30 days how it rolls out. There's complications and opportunities in all of those.And the interest has been as you know in the industrial market has been believably good. So, we'll have to evaluate what comes back in. But there's buyers and desire for all the components. The bulk is not part of what we put into the light format.

[Ryan Aceto:]

Got it. And then on that portfolio are you guys able to mention any kind of basis for it? Just trying to figure out any tax implications that will come down with the sale.

[Tom Barrack:]

Mark, I'll let you answer that. But we have not. It's a little premature to start giving forecasting. We anticipate that if we get the bids we expect that we'll respond to, we'll have a closing by year end and it will become evident then. Mark, any more information you want to share on that?

[Darren Tangen:]

Sure. We are actually -- this is Darren, why wouldn't I take that. Given what our cost basis is in that portfolio we -- and given where market values have gone, we would expect to realize a meaningful both accounting as well as taxable gain if we sort of sell where we're seeing other trades occur in the marketplace. So, as Tom said, more to come on that. We're mid-sale process. So, it's a little early to give guidance on that. But we would expect that there will be a pretty meaningful gain at the end of the day.

[Ryan Aceto:]

Great. That's very appreciated. If I could do one more. The proceeds from industrial assuming that sale does go through, I guess how do you guys think about share repurchase versus paying down preferreds versus convertible? Just any thoughts there would be great.

[Tom Barrack:]

Ryan, it's a great question. We've got lots of liquidity coming up. So, one of our big strategic initiatives is pruning and calling and delevering the balance sheet as we look at capital allocation opportunities going forward for the new businesses especially digital. So, we're in the process of knowing that we need to strengthen that balance sheet which we're going to do and that we have a gracious appetite for new capital to pin third-party capital especially within the digital arena. And by year-end, we'll have an arithmetic answer to that question.

[Ryan Aceto:]

Okay. Great. Thank you for your time.

[Tom Barrack:]

Thank you

[Operator:]

Our next question comes from Jade Rahmani with KBW. Please proceed with your question.

[Jade Rahmani:]

Thank you, very much. To start with Digital Bridge, how much operating income should we expect Digital Bridge to initially add on an annualized basis? I think there's about $7.3 billion of equity under management. Should we assume a 1% fee and 40% operating margin on that?

[Tom Barrack:]

Mark?

[Mark Hedstrom:]

I think that's a little light on the management company economics. And we think margins in the combination are going to be slightly better that over time as we go. It was a $325 million acquisition, so its contribution to earnings will be meaningful. But kept in context of the assets under management, we view it as incredibly important strategic transaction and not one that's entirely financially-driven although we're very optimistic and pleased with the acquisition that we made on a financial basis.

[Jade Rahmani:]

On the Digital Colony side, can you quantify what Colony's expected equity contribution to the Zayo acquisition will be? You mentioned there's a spend of capital that raised from third parties. So I'm wondering what CLNY's co-investment will be?

[Tom Barrack:]

Yes, it's Tom. So, if you remember, most of this lies within the fund. And the $6.5 billion of equity is split between EQT and Digital Colony. By the time that we're done with co-investment which has been unbelievably strong and a great demand, we'll probably have about $760 million from the fund that stays invested. So, we continue to co-invest down on what was a $15 billion total enterprise value acquisition, but that's where we think we are going to end up.

[Jade Rahmani:]

And so the $750 million, is that CLNY's co-investment? Or is CLNY's co-investment a subset of that?

[Tom Barrack:]

Well, that's DCP, that's the fund.

[Jade Rahmani:]

Okay. So what was CLNY's co-investment in the fund be?

[Mark Hedstrom:]

We have about 8% of that.

[Jade Rahmani:]

Okay. On the health care side -- say it again?

[Mark Hedstrom:]

About $70 million.

[Jade Rahmani:]

Okay. Got it. That's what I was thinking thereabout. On the health care side, with the bulk of refinancings now behind you guys and the VTR relationship expanded what would you say the outlook for the businesses do you intend to shift your focus toward strategic alternatives?

[Darren Tangen:]

Jade, it's Darren here.

[Tom Barrack:]

Let me take it. So -- absolutely. Look the Healthcare business is complicated and the skilled nursing business component of that is even more complicated. So it's taken us 18 months to get our arms around where the opportunities are and to really understand the flow of CapEx that's needed just to maintain where we are. Our strategic alignment with Debi has been terrific. They're a first-class organization. They have been in this business for a long time and GAHR was a step into looking at asset combinations and a future which makes a lot of sense.So Healthcare eventually for us has to go someplace. So whether it's a consolidation, whether it's a spin, whether it's an independent unification and part of that asset class is where we're going to go. So our team has done a great job. And as you've seen in the marketplace, a lot of people are enthusiastic and investing in the health care place. We need to clean it up. We need to get it understandable and then we needed to get it into its own silo. We are not sure what that own silo is yet, but that's the direction we'll go.

[Jade Rahmani:]

Turning to the industrial potential sale. Is it fair to say that your digital strategy going forward does not include industrial? Because, I know e-commerce has been a significant driver of the fervency that we've seen in the industrial sector.

[Tom Barrack:]

No. It absolutely, absolutely includes industrial. So, our industrial – Lew Friedland and his team if you remember, we acquired Cobalt. And we acquired Cobalt kind of like we're selling CIF. So we acquired the assets and then separately we acquired the management team. And then those assets those last mile logistical assets the type and quality and breed are irreplicable for what the team has done, but the adjunct of industrial going forward in the next wave. So we've looked at this and said okay the portfolio that we collected during that period of time was not really oriented entirely to following the logos.It ends up amazingly that Lew's tenants and customers are very much Marc's tenants and customers, but with different operating bandwidth. So on a go-forward basis of what we do with Digital when you look at the various businesses we are certainly going to be industrial and we're certainly going to be in infrastructure. But our goal has always been to identify, execute, buy build and sell for value and that's what we are doing. The way we formed CIF was an open-end fund. It's an open-end fund with foundational investors before the merger and right at the verge of going public. So as we simplify our balance sheet and trying to look at long-term value over time part of it is certainly the asset class and type of assets and the other part is how do we simplify our balance sheet going forward, so that we've got consistency. So industrial will be a part of the digital story. And the part of that is to continue on by following those logos. Again Tekken is – was the name of the game.

[Jade Rahmani:]

On the OED segment, is there the possibility for bulk portfolio sales to accelerate dispositions? I mean, if you want to simplify the balance sheet that's probably the most obvious place to start. There's already been significant amount of calling, but it seems like it does have quite a long life ahead.

[Tom Barrack:]

Yeah. It's Tom, again. There's no need to, because it's not that kind of OED. We don't need to take a discount to another wholesaler who's just going to take a 30% discount to us, so that they can sell to the same buyers that we know. It's a matter of distribution of that product over time and the markets are going our way. Some of it is a little more complicated, but the private market is understanding value where the public market doesn't. We're doing a good job. We're a little bit off this quarter, but the third quarter we're going to be even better. So we're going to continue to do what we're doing. We don't need to take a discount for bulk sales.

[Jade Rahmani:]

Okay. Thanks for taking the questions.

[Tom Barrack:]

Thank you.

[Operator:]

Our next question comes from Mitch Germain with JMP Securities. Please proceed with your question.

[Mitch Germain:]

Just maybe talk about the CEO transition and the rationale behind the 18 months – or at least 18 months transition?

[Tom Barrack:]

Yeah, so Marc currently has keyman language in our fund and that keyman language has limitations based on kind of a stair step basis of funds committed and funds spent. So as we looked at this in addition to figuring out how we synchronize all the other moving parts of the business what we envision was an 18 to 24 month period to transition both sides for us to transition our balance sheet away from some of the businesses that we don't see the meteoric opportunities or elements that we talked about before that I talked about it in the beginning of the earnings call, transition that into the other digital businesses as well as allow him the opportunity of understanding the components of those businesses and fulfill his obligations under the Digital Colony fund.So tower assets, small cell and fiber assets, data center hosting fiber enterprise, data centers, hyperscale data centers as we move through it will be the focus of what we have and it's going to take us a couple of years to get there.

[Mitch Germain:]

So is this arrival signaling a shift from traditional real estate toward digital real estate?

[Tom Barrack:]

Absolutely, but the shift from traditional real estate is a way – just a personal view. The way I look at it is we're dealing in obsolescence on a constant basis, so just the cycle of traditional real estate of the planning and entitlement process the architecture and construction process the leasing and sale process. By the time you envision a piece of land and get it incubated with the income in place, it's already obsolescent. And the users of that real estate, historically, right we are all looking for a triple net incomes from credit tenants and there's very few of those left. And the kind of things in every asset class that people wanted are changing at an unbelievable pace.So to follow the money, the big spenders of capital expenditures in bricks and mortar and bricks and mortar stuff are the technology companies. So, $165 billion in the next year. And that servicing of all things digital, the supplying those capital solutions with brick-and-mortar solutions and just looking at the big digital REITs, that have been split between tower assets and fiber has been amazingly interesting.So it's -- a balance is the same. We are going to hold the dividend. We've said, we will hold the dividend from 2019 and stay at REIT. We are. There's no change. But along that road the illusion between return of capital and return on capital is you had to have growth and you had to have total return.And we see more growth and more total return in the data and digital business and our acquisition of Digital Bridge and Ganzi and his team we think is best-in-class. And that's what we're going to point all of our silos towards as we move out of those businesses in which we don't have an edge and which we can't scale. We want to be the top three or four in every businesses that we're in.

[Mitch Germain:]

That's helpful. Liquidity is kind of about $400 million or so, or I think expanded more than that quarter-over-quarter. It seems like subsequent to the quarter there's a lot of different commitments energy to fund Digital Bridge. I'm just trying to understand the ability to fund those investments. And what's the plan there?

[Tom Barrack:]

Mark, you want to take that?

[Mark Hedstrom:]

Sure. Yeah, our liquidity was down period-over-period due significantly to the Digital Bridge acquisition and the refinancing transaction. We think, though that cash flow during the third quarter and the rest of the year puts us in very good stead to recover that and in the year with a very significant surplus. We still have $750 million line of credit available to us that is -- that's still in place. And we think our liquidity is good in the interim and good in the long-term. We see no issues there to fund any of the commitments that we currently make.

[Mitch Germain:]

All right. But what have you -- I think you mentioned during the call a bunch of the impairments were somewhat aligned with expectations. It seems like some of these impairments maybe in line with your expectations, but just not the investors and us. So, how much more of this can we expect? It seems like every quarter or every couple of quarters, pretty significant amount of impairments are realized. How much more is out there?

[Mark Hedstrom:]

I'll take that one. Look, as we realize small assets and as we call portfolios in our Healthcare and hospitality segments, that aren't held for sale. There is going to be noise and there's going to be gains and losses in those transactions as we go. I don't think that in -- for the year, we don't think that those gains and losses are that material to the operations of the business.We've got significant gain coming through OED in the sale of our NRE assets and bid management agreement. Those we hoped to get done in the second quarter. They came -- they will come in the third quarter with shareholder approval of that transaction and would have offset all of the losses that occurred.So, we hope there's a balance there. But as we call assets and sell assets, there's going to be timing issues related to gain and loss recognition. And we think that we ought to also focus on the recurring part of the business as well as lost -- gains and losses that are not necessarily recurring.

[Mitch Germain:]

All right. Last one for me. I think about $0.14 in the quarter, I think you had a little bit of one-time or least you referenced with Healthcare in the press releases. Anything else that needs to be pointed out with regards to thinking how clean was the quarter and what sort of adjustments that we need to do?

[Tom Barrack:]

Yeah. I think -- let me start, and then Mark and Darren can jump in. I -- the timing of what we're doing now, right, we're doing digging out of the hole. And the good news is the market has really helped us in digging out as we've gone from a gigantic defense, which you've all endured with us for the last 18 months to figuring out what is the offense. And we're clear on what the offense is now.We're going to clean up the balance sheet. We're going to simplify the business. We are going to turn to digital, and everything that relates to it including the emerging markets and credit. All of those silos are going to be digitally oriented and timing is the difficult thing as we call these other assets.So if you look at NRE, NRE was a major portion of our miss this quarter, because it was recorded a miss. So what Mark explained, I think we all feel confident. This year we're fine. We aren't at the level of surgical execution where we get the exact quarter right, especially on a lot of these dispositions which were quite complicated. But we've got the wind in our back. We understand where we're going. We've simplified a lot of the G&A and strategic process, which we're going to continue to do. But the great thing is now we've got an offense. So I don't think there's any surprises that I see. Mark, Darren?

[Mark Hedstrom:]

Got it, I think, that's right Tom. I would concur and again the timing of the NRE transaction would have been -- would have -- and the one-time charge for the health care refinancing, transaction costs, were several pennies of income during, the period even ex gains.

[Mitch Germain:]

Thanks.

[Operator:]

Ladies and gentlemen, we've reached the end of the question-and-answer session. At this time, I would like to turn the call back to, Tom Barrack, for closing comments.

[Tom Barrack:]

Thanks everybody. It's an exciting time for us. And just from my own personal point of view, it's one of those moments where after struggling through this, for the last nine months as you all have trying to figure out, not only what it is that we've got in the $22 billion balance sheet and $60 billion of assets, which by the way, in this market, I'm elated to have. Scaling up on anything is difficult and impossible.And going forward, on assets that have obsolescence in them and functional and financial issues is always difficult. What we've got now is a, forward program on all three legs.We understand the strategy. We are going to go to digital integration of all the businesses that make sense. The businesses that we have that don't make sense, that have economic viability. We are going to find the right capital structure. And place to home them.That will take us a little bit. But we know where we are going. And we've got, a great go-forward management team, adding Marc to the existing management team that we've got. And we are through most of the surprises. So, thanks for your patience.We are really looking forward to the future. And I think this next quarter and the arithmetic and math behind digital that we're going to give to you by the year-end, is going to be enlightening. So thanks everybody.

[Operator:]

This concludes today's conference. You may disconnect your line, at this time. And we thank you for your participation.