Current price: $23.5
Estimated Price: $27
Expiration Date: TBD
This idea was shared by Ilja.
Recent developments in Mack-Cali Realty (residential and office REIT) have caught my attention. It seems that company is moving towards partial or full sale and that this might help close the wide valuation gap relative to peers.
Here is a quick summary of recent events.:
- In February, Bow Street (owns 4.5%) issued unsolicited proposal to acquire CLI’s core office portfolio, but the offer was rejected by management.
- As a result, a proxy war started with Bow Street agitating to replace 4 out of 11 CLI directors with their own nominees. Until the last day CLI stood its ground and repelled all of Bow Street arguments, but very unexpectedly on the day of the meeting CLI withdrew 4 of their nominated directors leading to election of Bow Street candidates.
- The company used to be run by the second generation of the found Mack family - by brothers William (Chairman) and David (now an ex-director). David owns 4.5% of shares. The board tenure used to be very long (over 13 years), so given that they gave away those 4 seats now, especially one of them being David Mack’s, is definitely significant. Moreover, William Mack at 79 is expected to retire soon (mandatory age of 80).
- Before Bow Street went into action, CLI had two other interested suitors - Madison Realty (owns 5%) and Land & Buildings (owns 2%).
- Together with withdrawal of 4 director nominations, company also announced that it will be opting out of Maryland's unsolicited takeover statute (MUTA), which allowed CLI to unilaterally classify its board and get some protection from potential takeovers.
CLI trades at significant discount relative to peers - in terms of FFO multiple market values CLI at 13.5x compared to 16x average for office REITs and 20x average for residential REITs. Every turn of multiple improvement results in incremental $2/share for equity holders. For my base case I would expect CLI to be sold or valued at least at 16x multiple or at $27/share, which coincidentally is also a slight discount to consensus NAV ($28/share).
The discount is partially explained by higher leverage at CLI with net debt/EBITDA at 9.5x vs. 6.5x for office peers and 6x for residential peers. However, another part of the discount also stems from the distrust and underperformance of management - a factor that could be eliminated in case of sale.
Overall, keeping in mind the latest positive governance improvements and undervaluation relative to peers I consider CLI to be a safe asset to hold while waiting if anything transpires from Bow Street actions.
CLI is internally managed REIT that owns 45 office buildings (11.9m SF), 22 multi-family properties (6879 apartments), four parking/retail units (114k SF), two hotels and a parcel of land. Large part of its portfolio (60% NAV) is high grade office and residential units on the NJ waterfront. In 2015 the company has started a 3 year strategic initiative to refocus its business into more waterfront oriented, however it has really struggled with the re-leasing process. As a result, the company, or more correctly, the management, has received criticism (Glass Lewis, Egan Jones, ISS, Citi, JP Morgan and others) for its inability to create shareholder value, financial underperformance and failure to provide correct earnings guidance (more detailed in this Bow Street presentation and VIC article). In fact, Green Street Research has given CLI the worst corporate governance score out of the 79 REITS. So, governance issues are likely to be the main driver behind significant CLI discount relative to peers.
Bow Street has started to accumulate shares in Oct 2018 and in the end of Feb 2019 came forward unsolicited proposal to acquire most of the CLI office portfolio (more details below). Management rejected the proposal within couple of weeks.
As a result, Bow Street has started a proxy fight, throughout which, CLI management has strongly stood its ground claiming that Bow Street is only interested in a “fire sale” of CLI assets, which will be value destructive for the shareholders, so it was indeed very surprising when management withdrawn own director nominations on the day of the AGM.
Other interested suitors
In Sept 2018 Land & Buildings (owns about 2%), led by Jonathan Litt, former CLI director, has started spreading rumours that CLI has a potential suitor, who was ignored by the CLI management and because of that L&B has even considered to nominate a slate of directors themselves. It's quite possible, that the rumored suitor was Madison Realty as in Feb 2019 Madison Realty International has acquired 5% stake in CLI with such comments:
We acquired the shares at what we believe to be a discount to net asset value (NAV), and we believe Mack-Cali holds material upside potential. We see a significant discrepancy between how the public market is pricing the company’s shares and our private valuation.
So in case nothing comes out of the talks with Bow Street, we might see an offer from Madison or L&B.
Undervalued relative to peers
CLI is trading at significant discount relative to both office and residential REITs as indicated by the charts below.
Bow Street Proposal
The proposal stated that for the suburban and waterfront office assets CLI shareholders would receive a distribution of $8-$10/share, while the remaining residential asset portfolio was expected to trade for $19/share, therefore the total value created for the shareholders would be $27-$29/share (vs CLI price of $21/share at the time). CLI rejected the offer claiming that it undervalues the to-be-acquired office portfolio by about $1bn and that the distribution from the sale would be materially lower due to taxes and other costs. Management has also noted that proposal is based on unrealistic multiples for the remaining company and that the remaining company will not have sufficient cash flows to support its debt service obligations.
Bow Street is valuing RemainCo using management's NAV figures and does not apply any discount to it (whereas most REITs including CLI trade at discounts to their NAV). Moreover, CLI management kind of acknowledges that their $36/share NAV (for the whole company) is overstated as they present 'Consensus NAV' of only $28/share in their rebuttal presentation. Part of the difference in consensus vs management NAV is likely to be due to RemainCo assets.
Overall, I think management's comments regarding valuations are likely to be spot on - Bow Street offer undervalues the office portfolio (why else would they be willing to split it out) and overestimates the expected trading price of the residential portfolio. With Bow Street directors on CLI board valuation middle ground will likely be found.