Colony Capital, Inc.
Q2 2016 Earnings Call Transcript

Published: 9 Aug 2016

[Operator:]

Greetings and welcome to the Colony Capital Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host Lasse Glassen of Addo Investor Relations. Please go ahead.

[Lasse Glassen:]

Good morning, everyone, and welcome to Colony Capital, Inc.’s 2016 second quarter earnings conference call. With us today are the company’s Chief Executive Officer, Richard Saltzman; and Chief Financial Officer, Darren Tangen. Neale Redington, the company’s Chief Accounting Officer, is also on hand to answer questions. 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 company’s 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, 2016, and Colony Capital does not intend and undertakes no duty to update future events or circumstances. In addition, certain of the financial information presented on this call represents non-GAAP financial measures. The company’s earnings release which was released yesterday afternoon and is available on 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. And now I would like to turn the call over to Richard Saltzman, Chief Executive Officer of Colony Capital. Richard?

[Richard Saltzman:]

Thank you, Lasse. And welcome, everyone, to our second quarter 2016 earnings call. I’m very pleased to report the achievement of record quarterly Core FFO in the second quarter of $100 million or $0.75 per share. Included in these results were approximately $45 million or $0.34 per share of net gains, on which Darren will provide more details. The net gains realized this quarter more than compensate for its absence last quarter, and in fact, gets us close to achieving our historical annual run rate of $0.40 per share. Excluding these net gains, our regular-way [ph] run rate Core FFO was $0.41 per share, underpinned by solid foundational returns across our equity and debt platforms that are experiencing robust operational performance. In particular, our dedicated single-sector equity platforms, Colony Light Industrial or CLIP and Colony Starwood Homes, continue to post impressive year-over-year same store growth. At the beginning of this year, we laid out five top management priorities for 2016. With half the year now behind us, we’ve made significant progress on three of these. Number one, closing the merger of Colony American Homes and Starwood Waypoint Homes to create Colony Starwood Homes and demonstrating the efficacy of the business model through strong operating performance, with the overriding objective to close the GAAP between stated net asset value and trading value. Number two, positioning CLIP for the future through an evergreen permanent capital structure that among other things terms out floating rate acquisition debt and replaces it with long-term fixed rate debt. And number three, achieving certain corporate priorities that include refinancing our revolving line of credit and reducing overhead. The final two management priorities relate to fundraising targets, for both our global opportunistic credit fund and other initiatives. Admittedly, these would be more back-ended, based upon the slower pace of capital raising generally in the current market environment as well as the typical pattern for closed-end funds where investor prospects often wait until final closings to commit. Now, drilling down further on each of these priorities and starting with Colony Starwood Homes. The management team there has done a tremendous job in communicating their strategy and fully realizing the announced $50 million of annual synergies in just six months. Moreover, Colony Starwood Homes appears to be well on its way to achieving their targeted 2016 Core FFO with management increasing the low-end of their guidance from the $1.55 per share to $1.60 per share, while keeping the high end at $1.65 per share. Building on last quarter’s strong performance, Colony Starwood Homes produced solid same store results during the second quarter over the same quarter last year with revenue growth of 6.3%, net operating income growth of 7.8% and core net operating income margin of 62.8%. The company also closed on another non-recourse mortgage securitization, totaling approximately $500 million to optimize its balance sheet. As management is now delivering on all fronts, the company’s share price is now trading much more in line with its last reported NAV and we’re extremely pleased. As a reminder, CLNY continues to own 15.1 million shares of Colony Starwood Homes with a cost basis of $388 million compared to a market value of just under $500 million, based upon yesterday’s closing stock price of $32.89 per share. From the outset, we indicated it would take three to four years to build a business from scratch in an area that it had never been institutionalized. The learning curve by definition was steep. But we accomplished what we set out to do in the expected timeframe. Even better, Colony Starwood Homes’ best years are ahead of it, based upon excellent operating growth trends as well as very significant acquisition and consolidation opportunities. Moving to CLIP, this is increasingly becoming the poster-child for how we will strategically develop fortify permanent verticals in our go-forward business. First, it has an incredibly favorable fundamental tenant demand demographic, as one of the few real estate asset classes that is benefiting from technology, rather than being disrupted or dislocated. Owning the last mile of distribution in the e-commerce world of ever faster delivery times is extremely valuable. For example, CLIP achieved same store revenue growth of 6.6% and net operating income growth of 11.9% in the second quarter, compared to the same quarter last year. The second initiative for CLIP is terming out floating rate acquisition debt with long-term fixed rate debt. And to-date, CLIP has refinanced $303 million of floating rate debt and assigned term sheets to finance another $299 million with fixed rate debt. The combined $600 million of fixed rate debt will have a blended interest rate of 3.8% in a term of 13 years, providing plenty of duration on assets we plan to own for the long run. All of this has appropriately positioned us to recently launch a private evergreen fund raising initiative for CLIP, which we hope to report on by yearend. On our corporate initiatives, we have successfully refinanced our $800 million revolver on meaningfully better terms, and we have also reduced our company headcount, since second quarter 2015 and introduces some performance-based compensation arrangements that we expect to generate annualized cost savings of approximately $10 million plus or minus relative to 2015 levels. Last but not least, on capital raising we have limited information that we can share today based upon legal constraints. But as mentioned earlier, market conditions have led to some investor nervousness, which generally is extending the timeframe by which we believe we will achieve our targets. Nonetheless, we hope to be in a position by yearend to report on some meaningful progress on our various capital raising initiatives. Turning to the merger with NorthStar Asset Management and NorthStar Realty Finance, the preliminary proxy filing occurred on July 29. Concurrent with the filing of the preliminary proxy, Colony and the NorthStar entities jointly published a new appendix to the June 7 merger presentation, which highlights two pieces of analyses we believe are helpful in understanding the value of the pro forma company. First, we communicated Colony NorthStar’s intent to repurchase its common stock or further deleverage in an amount up to $1 billion following the close of the transaction and subject to market conditions. The second part of the appendix provides a reconciliation of pro forma full year 2015 and first quarter 2016 Core FFO/CAD to GAAP net income which is detailed in the joint proxy. In terms of next steps, we expect to file the final proxy statement sometime after Labor Day, with the shareholder vote slated for late October or November. Pending receipt of shareholder and regulatory approvals, we expect to close the transaction in January 2017. In the meantime, our planning teams have been diligently preparing to combine the three companies. This includes both integration issues, as well as strategic planning. In fact, we engaged Deloitte Consulting to assist us on various integration matters, and suffice it to say, we are convinced now more than ever that this merger will be a good fit for our business, for our shareholders and for our employees, at a time when size and scale is critical in the real estate and investment management businesses. We do appreciate that the merger is an interim half to a full step backwards towards our goal of simplifying our business on the one hand. On the other hand, from this complexity exist the potential to become a category-killer, top-tier owner and investment manager. Our workload for sure is increasing, but we believe the opportunity is well worth the effort. If you look back at our history in the public markets, we have consistently done what we said we were going to do, usually on-schedule, although occasionally with some delay. But the consistency is there, including now with our single family for rent business, as I highlighted earlier. As most of you know, we are not afraid of challenges nor complexity. This is often directly proportional to the scale of the opportunity. And we are highly confident that the merger with NSAM and NRF will provide much more or the same on a super-scaled level. In conclusion, we were able to achieve a record level of Core FFO through rigorous investment underwriting and asset management, combined with the fostering of strategic verticals such as CLIP and Colony Starwood Homes. And the tri-party merger is the next step in our evolution to turbo-charge our growth and success. We couldn’t be more excited about that future. And now, I’m going to turn the call over to Darren Tangen, our CFO for a more detailed summary of our second quarter operational and financial results.

[Darren Tangen:]

Thank you, Richard. Before my remarks on our second quarter results, I’d like to remind our listeners that we filed the supplemental financial package concurrently with our earnings release yesterday, and both of these documents are available on our website. Second quarter Core FFO was $100 million or $0.75 per share, a record high, due to $45 million or $0.34 per share of net gains. This result more than puts us back on track to achieve the recent historical annualized level of approximately $0.40 per share of net gain contribution to our Core FFO, as discussed on our last call. The majority of the net gains in the second quarter resulted from the realization of a profit participation in a multifamily portfolio with the balance of the gains coming from prepayment fees, preference payments within CLIP and foreclosure gains net of loan loss provisions. Excluding net gains, our normalized second quarter Core FFO was $0.41 per share, which fully covered our quarterly dividend of $0.40 per share. So going back to the largest component of our net gains, in 2013 we invested a $127 million of preferred equity to finance the acquisition and renovation of 20 apartment communities across various Sunbelt States. Our investment was structured to earn a preferred 12% internal rate of return, ahead of the sponsor achieving a 12% internal rate of return on their common equity investment followed by our 30% profit participation. Since 2013, the sponsor has done an incredible job executing the business plan and creating value in the portfolio, as demonstrated by a 40% increase in portfolio net operating income. With the portfolio now stabilized, the sponsor approached us earlier this year to extend the duration of our outstanding preferred equity in exchange for a cash-redemption of our subordinated profits interest based upon and agreed upon liquidation value. Since the peak investment amount of $127 million in 2013, the sponsor has also made partial redemptions of the outstanding preferred equity along the way, using excess cash flow and mortgage refinancing proceeds. The outstanding balance on the preferred equity was $98 million as of the end of the second quarter, where it still earns a preferred 12% but no longer has a subordinated profits interest. This is a great example of a latent gain within our investment portfolio that wasn’t apparent in our book value, but it’s consistent with remarks we have made in the past about being a total return investor, combining both current yield and back-end capital appreciation. Turning to capital deployment, investment activity has picked up since first quarter. Since the end of March, we have invested or committed to invest $522 million for the balance sheet and funds managed by Colony, spanning four of our five reported segments, including CLIP, other real estate equity, real estate debt, and investment management. Approximately $200 million of the $522 million came from the balance sheet and geographically this capital deployment was 90% in the United States and 10% in Europe, specifically Germany. Recent bid-out spreads in Europe have widened. And we are proceeding carefully, given heightened financial and political volatility in the region. The Brexit vote was yet another reminder of the economic and political fragility in Europe and the continued need to appropriately pricing that risk in our targeted returns. Despite this cautious stance, our organization has historically thrived during market dislocation and periods of banking system distress. And therefore, we expect Europe to remain a fertile ground for attractive capital deployment opportunities. With respect to our balance sheet exposure to European investments, the impact from this recent volatility has thus far been minimal. In the second quarter, unrealized currency translation losses were approximately $23 million, which in turn were offset by approximately $17 million in currency hedge gains. Both of which are accounted for in other comprehensive income on our balance sheet, but not in our net income or Core FFO. The company’s investment portfolio exposure to the United Kingdom is only 5% as of June 30, and less than 20% exposure to Europe in the aggregate. Now, I’ll touch on some financial and asset management updates for each of our five reportable segments. CLIP continues to outperform with second quarter 2016 core FFO contribution of $17.5 million or $0.13 per share. CLIP’s core FFO did include approximately $2 million of a one-time general partner preference payment, but even excluding this amount second quarter annualized Core FFO yield was 11% against our average equity investment for the period and represented a meaningful improvement over prior quarter and last year. CLIP still has $163 million of uncalled capital commitments including our 62% share and $100 million undrawn on its acquisition facility, which is sufficient to carry out its investment program in the near term, while we work on expanding its third-party capital base. Turning to our Single Family Residential Rentals segment, Colony Starwood Homes achieved strong same-store results in the second quarter over prior year with revenue and net operating income growth of 6.3% and 7.8% respectively. Second quarter Core FFO contribution from the segment was $0.04 per share, which includes Colony American Finance. As Richard noted, we are finally beginning to witness the fruits of our labor as represented by Colony Starwood Homes’ recent stock price performance, which now reflect the meaningful unrealized capital gain on our original investment in Colony American Homes. Next is our Other Real Estate Equity segment where approximately 65% of the net book value represents opportunistic real estate investments, generally made through joint ventures with funds managed by the company and includes our investment in Safeway/Albertsons, and 35% represents triple net lease investments. Second quarter Core FFO was $50 million or $0.37 per share including the gain from the redemption of the profit participation interest in the multifamily preferred equity investment. Excluding gains, this segment yields at an annualized 7% on the segment’s average equity investment in the second quarter, notwithstanding the fact that several was the investments in this segment such as Safeway/Albertsons are earning no or very little current yield. Net book value for our debt segment at the end of the second quarter was $2 billion and second quarter Core FFO contribution was $60.5 million or $0.45 per share. Our book of originations made up 79% of this segment. Of this 24% was composed of first mortgages and 76% was composed of leveraged first mortgages, B-notes, mezzanine loans and other subordinate debt. The total originations book sat between a weighted average first dollar loan to value of 35% and a weighted average last dollar loan to value of 74%, and generated a blended yield of 12%. The 21% balance of our real estate debt segment is composed of loan acquisitions, which produced an annualized second quarter Core FFO yield of 11%, excluding loan loss provisions. Lastly, our investment management segment produced second quarter Core FFO of $5.9 million, which was down $3 million from last quarter. Assets under management ended the quarter at $18.4 billion and fee earning equity under management ended the quarter at $7.6 billion. While AUM slightly increased since last quarter, fee earning equity under management decreased approximately $300 million, primarily as a result of certain investment realization in legacy funds being in excess of new capital commitments. As Richard mentioned, we are making good albeit slower than originally expected progress on the fund raising front and plan to have a meaningful update by the end of the year on our global credit funds, CLIP, and other fund raising initiatives. And now, a quick update on corporate leverage and liquidity. As of June 30, leverage held basically steady at 49% debt to assets. For liquidity, we had approximately $430 million drawn on our $850 million corporate credit facility as of quarter end, and inclusive of the CLIP credit facility, cash on hand and near term expected repayments, we have in excess of $800 million of near-term liquidity. In conclusion, we have an outstanding quarter bolstered by some sizeable gains and we still have much more value and capital to harvest within our investment portfolio in the next few years. But importantly, we also continue to own high quality assets and businesses that serve as the foundations for producing stable recurring earnings in the future. This positions us well to form a world-class real estate and investment management platform under the proposed tri-party merger with NorthStar Reality Finance and NorthStar Asset Management company and substantially advance our pursuit to become the leading diversified equity REIT with an embedded institutional and retail investment management business. With that, I’d like to turn the call over to the operator to begin questions and answers. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Jade Rahmani from KBW.

[Jade Rahmani:]

Hi, thanks for taking my questions. Just on your UK exposure, how do you view the risks there within the other real estate equity portfolio?

[Richard Saltzman:]

Hey, Jade. Good morning. Thanks for the question. So our exposure in the UK is, generally speaking, outside London, more regional exposure. And that part of the market seemingly is a lot less impacted or affected by potential Brexit ramifications if you will. At least, that seems to be common wisdom with the current moment. And so we’re pretty sanguine about our exposure in the UK. And so far it still remains to be seen, what the real consequences of Brexit are going to be just in terms of - is this really going to be an exit or is it going to be some more negotiation and compromise. But our exposure is outside London.

[Jade Rahmani:]

And are those properties stabilized?

[Richard Saltzman:]

Generally, yes. We have exposure to some retail, some office, and generally speaking these are leased to smaller tenants and stable.

[Jade Rahmani:]

And so far there has been no performance deterioration?

[Richard Saltzman:]

No, in fact the opposite, I mean, I think we’re continuing to make progress from the standpoint of any absorption that we were expecting on vacancy as well as some smaller potential asset sales at prices that are equal to or maybe even better than our underwriting.

[Jade Rahmani:]

The gains on - real estate gains on asset sales were very strong this quarter. And I think in the Colony NorthStar proxy there is standalone projections for 2016 through 2018 for Colony. Do you anticipate gains? I mean, I would assume they moderate, but would you anticipate continued gains in the next two quarters?

[Darren Tangen:]

Yes, Jade, it’s Darren here. We do - I mean, I think we are expecting some gains between now and the end of the year. And as I said in my remarks, we have more value to harvest in our investment portfolio over the next couple of years. So we do expect gains to be a part of our earnings profile for the next few years.

[Jade Rahmani:]

And I guess in October the lockup expiration takes place on the Colony Starwood Homes investment. How are you thinking about that, and whether you’d consider potentially monetizing part of that this year?

[Richard Saltzman:]

Well, look, we are monitoring it carefully as we are - kind of everything from an asset management standpoint, but no decisions have been taken and we still have some time to go until that expiration actually occurs.

[Jade Rahmani:]

And just on the cost side, I think you noted $10 million in annualized expense savings. Is that going to flow through the compensation cost line, because it’s just on the admin side, I guess, that line, administrative expenses have been coming in a bit above what we were projecting?

[Darren Tangen:]

Yes, Jade, I’ll take that. So, yes, all of the savings that Richard mentioned are in the compensations line item not in the administrative expense line item.

[Jade Rahmani:]

Okay, and just finally on the investment activity side, I think you commented about 90% of your investments have been focused on the U.S. And where are you seeing the most attractive investment opportunities right now?

[Richard Saltzman:]

Well, I think a fair amount of that activity has been through CLIP. And the other part of the activity really has been some new originations on the debt side of our business that are actually residing in our new opportunistic global credit fund, where CLNY has 20%participation.

[Jade Rahmani:]

Thanks very much for taking my questions.

[Richard Saltzman:]

Thank you, Jade.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from Mitch Germain from JMP Securities.

[Mitch Germain:]

Hey, good afternoon, guys. I just - Richard, your comments on the fundraising environment, is it a function of things taking longer or is it a function of maybe a little less capital that’s targeting real estate?

[Richard Saltzman:]

So, good question, Mitch. Look, I think it is just things taking longer. I mean if you look at any of the published data here in 2016 on fundraising versus fundraising in 2015, I think for alternatives it’s decelerated broadly, including in real estate. I mean, I think the appetite for real estate from a relative standpoint still is quite strong, based on a combination of just attractiveness from a relative yield standpoint, as well as very sound fundamental supply-demand considerations. But I think the environment with all of the uncertainty just around central banks and interest rates and now Brexit have just caused a slowdown in people, whether it’s institutional capital or even retail capital the willingness to commit on a timely basis. So things get pushed out. We have anecdotal evidence of many funds being delayed in reaching their targets and just pushing out the length over which they’re doing their fundraising. And it appears to be that more than anything else and we’re still cautiously optimistic we’re going to achieve our goals.

[Mitch Germain:]

Is there any though on your end to possibly pursue something post-Brexit, maybe in the UK?

[Richard Saltzman:]

Well, I mean, yes, we have a good team on the ground in the UK. And we talk about opportunities all the time. And of course part of the nervousness around the UK has led to deterioration in the currency, which is also a consideration in terms of us being a dollar-denominated investor, and what our basis would be in the UK. But I made the comments just about London versus outside of London. I mean, it does appear that there is more risk within London. On the other hand, maybe there is going to be more distressed pricing in London, but it remains to be seen.

[Mitch Germain:]

Thank you.

[Richard Saltzman:]

You’re welcome. Thank you.

[Operator:]

Thank you. [Operator Instructions] We appear to have no further questions. I will turn the call back over to management for closing comments.

[Richard Saltzman:]

Okay, well, thanks, everyone, for joining us today. It was a great quarter and we’re very excited about our future, and in particular, hopefully the merger occurring just at the beginning of next year as we’ve described. And we appreciate your support, and look forward to reporting further on our progress. Have a great rest of the day.

[Operator:]

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.