Bluerock Residential Growth REIT (BRG) – Merger + Spin-Off – 12% Upside

Current Price: $26.63

Acquisition Price: $24.25 + $5.60 est. SpinCo NAV

Upside: 12%

Estimated Completion: Q2 2022

This idea was shared by Brett.

 

Bluerock Residential Growth REIT is a real estate investment trust that owns a portfolio of multifamily and single-family rental properties. In December 2021 it was announced that Blackstone (BX) had entered into a definitive agreement with BRG to acquire the Company for $24.25 per share in an all-cash transaction. Prior to the acquisition, BRG will be spinning off its single-family rental business to shareholders. This spun-off entity will become a new REIT called Bluerock Homes Trust with a ticker symbol BHOM. The spin-off and subsequent acquisition are expected to be completed in Q2 2022.

Blackstone’s acquisition offer was at a significant premium to the average closing price of BRG of $11.55 in 2021 and the stock jumped 75% on the news of the offer. However, it seems as though the market is still not attributing proper value to the SpinCo. Prior to the announcement, Duff & Phelps conducted an independent review of the SpinCo and assigned a midpoint NAV of $5.60 per share. Given the current share price of BRG, the market is discounting this NAV by 60%. This NAV estimate should reflect the fair market value of SpinCo’s assets/investments (including pref and mortgages). Duff & Phelps is also a very reputable firm so their assessment of SpinCo’s NAV should be reliable. I used total invested equity per share as a proxy to check the D&P NAV (especially since most of the investments were originated in the last year), which showed that BRG’s equity cost basis in these assets is approximately $5.80. Hence, a midpoint NAV of $5.60 per share would seem reasonable and when you count for some added corporate expenses, I think it makes a lot of sense at $5.60 vs $5.83 investment at cost number.

One key will be understanding whether there will be any debt or long-term liabilities, aside from the $35 million currently secured by two of the SpinCo’s assets, that will be added to the new company’s balance sheet, which could dilute book value. However, aside from these two mortgages (Navigator Villas and Yauger Park Villas), there are really no other outstanding forms of debt on BRGs balance sheet to transfer. I assume there will be some other liabilities transferred as well but don’t expect the amount will be too meaningful. I would think that they will secure a credit facility but not sure there would be a reason to draw on it at the beginning.

I have been informed that BRG expects to file a Form 10 at the beginning of March which will include a pro forma balance sheet that should answer the question as to any debt that may be added to the SpinCo. Form 10 will also provide a pro forma income statement to better understand the implied cap rate based on the income of the SpinCo’s properties.

 

Risks

Really the main risk here is the acquisition not closing, however, I think that the chances of that happening are low. The BX deal is not contingent on financing, and I can say having worked directly with BX in real estate for years, a BX deal is about as close as you can get to 100% certainty of close. They are probably the best financial buyer out there. So the larger threat to not closing would be BRG’s inability to facilitate the spin-off (it is a condition of closing), which I also think is quite unlikely.

Additionally, the Company announced in September that it was exploring strategic options, including a sale, so there was likely a competitive bid process that produced back up bidders that could step in should the deal with BX fall through.

The deal has been unanimously approved by BRG’s board of directors and the last step for full approval is a shareholder vote, which should have little problem passing.

All-in-all I believe the risk profile here is quite low.

 

Conclusion

This is a reasonably straightforward deal that offers solid upside, with what, in my opinion, is very little downside risk. The max loss here (aside from the deal not closing) is approximately 8% if the SpinCo market cap goes to zero, which is extremely improbable. To lose money at all, the SpinCo would have to continuously trade at a discount to NAV of over 60%, which again is unlikely. As of 1/28/2022 the two single-family home REITS (albeit way larger than the spinco), AMH and INVH, trade at an average discount of 6.4% to consensus NAV (which reflects the fair market value of properties) and an average premium of 9.8% to Green Street’s NAV estimates. Green Street is the top REIT advisory and consulting firm.

Note: It may be advisable to wait for the Form 10 to come out so there is a little more certainty around the capitalization of the SpinCo, but like I said, the Duff & Phelps estimate should be pretty reliable.

26 COMMENTS

  1. dt

    Thanks. What do you think is the market missing/seeing differently for this situation to be trading at 12% spread.
    Is it:
    – Small risk of transaction breaking either due to BX walking away or management failing to do the spin-off;
    – Uncertainty re spin-off trading price;
    – Something else?

  2. brettrush1

    Take this with a grain of salt, as I never really feel like I have a great answer as to why some of these special sit/arb spreads exist. My guess would be a lack of understanding of the SpinCo. Really the only piece out there about it’s value is the $5.60 NAV estimate by D&P that was announced in the press release. It took quite a bid of digging to actually understand that investment at cost number, especially because they have common, pref, and mortgage positions on the Peak Housing portfolio (their largest holding). It just took a lot of piecing together from filings to understand the investment at cost number as they don’t really make it clear-cut anywhere.

    I suspect the market is generally discounting the D&P number (although it seems like a really big discount) and many haven’t done the homework to see that it seems to make sense.

    Like I said though, take with a grain of salt, as my honest answer is “I don’t really know.”

  3. Paul

    I have looked at this before and if I remember correctly, the SpinCo will be externally managed by Bluerock management. Because of this, I think there is a third small risk. The market could discount the SpinCo, as management did not act value creative previously with lots of preffered stock issued for BRG, leading to a NAV discount. Maybe the Spin will trade on a NAV discount shortly after the spin, so you would need to sell fast enough?

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    1. brettrush1

      Yes, I should have mentioned that. Bluerock got a bad rap (deservedly so) for the excessive pref issuance with BRG, so it is very possible that is leading to the current discount. My thought is that this will be a clean slate (or should be, I guess we won’t know for sure until the Form 10) and the capitalization of the SpinCo should be nice and tidy which will hopefully lead to it trading closer to its NAV, or like you said, at least in the beginning.

      I like your point about selling fast though. I’m going to try to not to be greedy. I really see this as a low downside play with reasonable upside so worth taking a position and can use some margin to juice it a little due to lower risk.

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  4. Jason

    They are claiming the spinoff is taxable compared to most spinoff which are tax free. I’m not very knowledgeable about how that works, but if you in theory are taxed on the 5.60, then then the opportunity looks more like a standard risk/return for the certainty of completion.

    If that is really is how it works, do it in a tax advantaged account.

  5. amirattaar

    why aren’t you moving over the $35m in debt in your base case analysis? Is there some reason to believe this debt won’t reside with BHOM?

  6. dt

    If BRG spin is taxed at 15% and then trades at a discount to NAV of let’s say 20% due to external management or other issues, then the market might be pricing this situation quite efficiently – combined after-tax consideration of $27.8/share or 5% spread to current prices.

    The setup is more favorable for investors that will not be subject to taxes on the spin.

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  7. g4734g

    The July 22.5 puts at .4-.7 are telling that there is some deal risk, as the cash component of the deal alone is $2 above the strike……I would assume these turn into a deliverable of 24.25 cash and spinco shares

  8. blades

    Duff & Phelps did not show much rectitude in its RENN valuation. Not sure I trust them, but like the spin dynamics and low risk (assuming BX is solid)

  9. brettrush1

    More on the tax treatment from today’s proxy:

    “The receipt of cash by U.S. holders in exchange for shares of Common Stock pursuant to the merger, taken together with the distribution, is expected to be treated as a distribution in complete liquidation of the Company and a fully taxable transaction for U.S. federal income tax purposes. In general, a U.S. holder of shares of Common Stock will recognize capital gain or loss for U.S. federal income tax purposes in an amount equal to the difference, if any, between (1) the sum of (A) the amount of cash received with respect to such U.S. holder’s shares of Common Stock in the merger, plus (B) the fair market value, determined when the distribution occurs, of the shares of Bluerock Homes common stock received in the distribution, and (2) the U.S. holder’s adjusted tax basis in its shares of Common Stock.”

    Sounds like BRG will be the one to assign a “fair market value” to give to the IRS for the tax purposes, however if the stock were to trade materially higher than the value given by BRG after the spin, the IRS could increase it. In any case, as dt and Jason noted this is a better setup for those using a tax advantaged account. It’s unfortunate that the spin-off shares are treated as part of the liquidation. I was hopeful that because the spin-off and merger were happening concurrently the “taxable” language referred to the cash portion only. That was a bad oversight.

    On a better note, it looks like shareholders may receive a dividend payment or two prior to the closing (see below from proxy). Albeit that still falls under the tax issue, but pre-tax upside may be up to 14% from today’s price. After accounting for the high-end of the US tax bracket (40%) would take you to about 9%. So still decent potential.

    “Q: Will I receive any regular quarterly dividends with respect to the shares of Common Stock that I own?

    A: On December 10, 2021, our board of directors authorized and we declared a quarterly cash dividend of $0.1625 per share of Common Stock for the quarter ended December 31, 2021, which was paid in cash on January 5, 2022, to holders of record of our Common Stock at the close of business on December 23, 2021. Under the terms of the merger agreement, we may make, declare and pay regular quarterly cash dividends on Common Stock for the fiscal quarters ending March 30, 2022, and June 30, 2022, in amounts up to $0.1625 per share per quarter (with record and payment dates consistent with historical record and payments dates for fiscal year 2021). Under the terms of the merger agreement, we may not authorize, declare or pay any other dividends to the holders of shares of Common Stock for fiscal quarters ending after June 30, 2022, without the prior written consent of Parent, other than dividends reasonably determined to be required to maintain our status as a REIT under the Code or to avoid the payment of income or excise tax or any other entity-level tax (with any such additional required dividend resulting in a corresponding decrease to the merger consideration).”

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  10. Nomad

    Some additional color from Morgan Stanley on the stub value of the Homes business:

    Bluerock Homes Common Stock
    Morgan Stanley reviewed and compared certain publicly available financial information, publicly available ratios and publicly available market multiples regarding publicly traded U.S. single-family REITs and publicly traded externally managed REITs, which companies shared certain business characteristics with Bluerock Homes, including Bluerock Homes’ expected leverage, structure and geographical profile. Morgan Stanley then applied the 2022 consensus EBITDA multiple, 2022 consensus FFO multiple and Premium/Discount to the mean consensus estimated NAV, in each case, of certain of these comparable companies to our management’s financial projections and estimates with respect to Bluerock Homes’s NAV, EBITDA and FFO, each as described in the section entitled “Forward-Looking Financial Information,” in order to derive a reference range of implied trading value of Bluerock Homes per share of Bluerock Residential Common Stock of $3.45 to $5.98 per share of Bluerock Residential Common Stock, as compared to the $5.60 NAV of Bluerock Homes per share of Bluerock Residential Common Stock, based on management’s estimate of Bluerock Homes’ NAV of $494 million.

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  11. g4734g

    BRG announced 3q earning on NOV 4 meaning q4 should have been early feb…..Does not look like they annunced earnings…..are tehy foregoing this based on the upcoming spin and merger?

  12. ddagtrader

    Does anyone have an idea of how soon the merger will close? I know it says that it is projected to close sometime in Q2, but is there any update on the timeline?

  13. pmgs

    Thanks for the interesting idea. Couple of questions that have came up as I looked at the Form 10 that was recently filled, I was wondering if anyone more familiar with the situation could clarify:

    1. Page 42 of the Form 10 shares states that “Some of our current investments, generally in development projects, have been made through joint venture arrangements with various investment funds affiliated with affiliates of our Manager, which were not the result of arm’s-length negotiations of the type normally conducted between unrelated co-venturers, and which could result in a disproportionate benefit to affiliates of our Manager.” Any idea what these projects and how bad the conflicts of interest are?

    2. Is the $68m of mortgages payables shown on the pro forma balance sheet on page 81 of the Form 10 all the property level debt in your properties? Or is there additional property debt that is not consolidated into Bluerock’s balance sheet on this line? Also, are all these mortgages non-recourse to Bluerock?

    3. Is the pro forma balance sheet presented for the spinCo on the Form 10 mostly final on the debt side, or is the expectation that debt will be added on top of what is presented there?

  14. ddagtrader

    I haven’t seen a spinoff announcement or any real news on this, and Q2 is basically done. Has anyone seen any updates? I called IR for Bluerock, but no response there either.

  15. Jim

    I have a dumb question- doesn’t the pro rata distribution 1:8 BRG to BHM mean that on a per share basis the return is lower? Thanks for considering my question.

    1. dt

      The $5.6 spin-co value In the write-up was indicated on the basis per BRG share. It is not relevant if you receive this in the form of one spin-co share or 8 spin-co shares, the total value of spin-off distribution will be the same.

  16. Ilja

    BRG’s board has approved the distribution of spun-off entity shares to BRG’s shareholders. The spin-off is expected to be completed on October 6. The last date to purchase BRG’s shares and be entitled for distribution of BHM shares (i.e. the record date) will be September 29. At current BRG prices, BHM is valued at only $2.63/share vs $5.6/share value previously estimated by Duff & Phelps. 

    https://www.bamsec.com/filing/110465922102365?cik=1442626

  17. jwestern

    What’s the play here — buy before the spin, or try to buy depressed post-spin spinco shares?

  18. brettrush1

    While I do own shares currently, I think what has happened to residential housing since the announcement of the deal (and this original post) may put extra selling pressure on the spinco in the days following the spin. I would think the move right now is to buy post spin if there is a significant selloff.

    I could be wrong though as many people think increased home prices + interest rates will keep people renting for the foreseeable future and put upward pressure on residential rents which would be good for the spinco.

    I will definitely be watching this closely.

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