Description

EVOQ Properties, Inc. was formerly known as Meruelo Maddux Properties.

Outline:

- EVOQ is a private real estate owner in downtownLos Angeles

- Was in bankruptcy from early ’09 until late ’11 and silent since

- Two competing plans were offered – one values equity at $5, the other at $15

- The winning plan sponsor invests cash at an equity value of $1.75, plans to sell non-core assets to raise more cash, and re-invest that capital into core assets

- Cash generated from property sales around that time was $2 per share which protects downside, and implying an equity value significantly above the lower $5 book value

- 1% decrease in cap rate increases stock book value by ~$5

- Ways to easily increase value include re-financing at lower rates and increase occupancy rates from below market levels due to prior mismanagement

- Overall, a cheap option on a levered company where there are a lot of ways to create value

- Catalyst is completing audit and reporting updated financials.

- Further catalyst will be increased visibility to non-core asset sales progress

A brief description from LinkedIn:

EVOQ Properties, Inc. (“EVOQ Properties” or “EVOQ”) is a publicly owned real estate private equity firm headquartered in Downtown Los Angeles. EVOQ’s existing portfolio of 34 assets includes approximately 3.5 million square feet in the greaterLos Angelesarea with a focus on industrial, creative office and multifamily residential assets. Properties include a mix of operating, redevelopment and land assets, with significant value-add opportunities across the portfolio. The firm is backed by strong institutional sponsorship from Mount Kellett Capital Management LP. EVOQ is well capitalized and positioned to deliver superior risk adjusted returns to investors through the management and redevelopment of core assets within the acquired portfolio, the strategic disposition of select non-core assets, and the execution of joint venture development partnerships to build best-in-class properties.

EVOQ Properties emerged from bankruptcy last July.  Since then, the company has remained silent and the stock has been forgotten.  While it’s rational to apply some discount for the illiquidity and lack of communications, I think that discount is overdone and the stock offers compelling upside of more than 100%, and potentially multiples of that.  Because of the lack of updated information available, my goal in this writeup is not to come up with a value for EVOQ, but instead, I want to point out a range of reasonable/likely values, and argue that the stock should trade at least at the bottom end of that range. The catalyst to increase the share price should be audited financials and company communications.

To frame the upside/downside scenarios, in bankruptcy, two major plans contemplated split adjusted book value of ~$5 and ~$15.  The $5 plan was set forth by Charlestown/Hartland Asset Management and emerged as the winner.  The second plan was put forth by former management.  Of course, former management was incentivized to overestimate the book value in order to remain as management.  On the same token,Charlestownhad an incentive to low ball their estimate of book value – their plan was buying 55% of the company at $1.75 - the larger their estimate of book value, the less “fair” $1.75 would seem.

Charlestown’s plan (now current management) was sell non-core assets and use that money to improve the quality and increase the occupancy rate of “core” assets, although the plan didn’t specify which properties were considered “core”.  In fact, I don’t think management knew at that time.  My sense is that they knew that the properties were a bunch of unrelated properties acquired over the years without a cohesive strategy, which during bankruptcy, could be acquired in aggregate at a discount to fair value.  The logical course of action is to begin selling properties to see where the bids lie, and at what prices, before making decisions as to which properties to keep as core.  While this requires some faith in management’s ability to navigate through the portfolio, I am comforted that the market severely handicaps the outcome by offering the stock at 60% of an already potentially understated book value.

As they sold properties, the initial indications were for sale prices that were higher than book value.  On Ycombinator’s thread for MMPIQ (posts 22 and 24), he gave a good overview where properties were selling.  Generally, sale prices were closer to the $15 BV estimate than the $5 BV estimate.  Likely, the sales were the low hanging fruit, but they were over $2 of BV on just those 5 sales.  This alone would argue that the stock should be valued at $5, at minimum.  I’m working on trying to put together a more complete picture of which specific properties have been sold and at what price, although I don’t have that ready yet.  My intention is to post it to the Q&A section.

Here is a link showing some real estate trends in LA:

http://www.loopnet.com/Los%20Angeles_CA_Market-Trends?linkcode=31070

While there is no clear trend, I think the important thing to notice is that the market hasn’t worsened significantly.  For now, even a stable market environment helps EVOQ – it will give them the time to continue to monetize the book value of non-core properties.

It’s also important to note that the company is levered.  A 1% decline in the cap rate equates to a $5 increase in theoretical book value.  If there is no other reason to hold this stock, one reason is that at these prices, the stock is a very cheap option to a real estate recovery in LA.  Of course, leverage works in both ways, but at these prices, the optionality is too cheap.  As of last year, there was $2+ of cash on the balance sheet.  The description from LinkedIn above says “well-capitalized” and that was put up more recently.  Again, I have to rely on faith, but it would be hard for management to squander all of the cash, and it would also violate the strategy they laid out upon emergence of selling non core assets to raise cash to redeploy into core assets.

In my mind, the strategy that makes the most sense, especially given managements background, is for the company to sell undeveloped properties and focus their efforts on income producing properties.  If they pursue that strategy and can make headway, I think there are two other levers they can pull to increase shareholder value.  First, and this seems relatively easy to do, is to re-finance some of the properties at lower rates.  During bankruptcy, the company was in a state of limbo where they couldn’t focus entirely on their properties.  Vacancy rates were high and it would seem like a mere focus addressing this issue would yield substantial improvement.  Some of their properties were only 60% leased, a significantly lower percentage than the surrounding local markets.  The second lever is that they could potentially convert to a REIT at some point in the future which should get a higher multiple.  For now, it’s premature to factor in, but I’m pointing out how a little success early on can lead to more ways to unlock value.

Catalysts:

Audited financials

Further catalyst will be increased visibility to non-core asset sales progress

Lower financing costs

Risks:

Real estate exposure – if LA real estate market softens, the assets will be harder to sell (thus harder for the company to pursue their plan)

Financials – the company was in bankruptcy.  It’s unclear what the complete picture will look like after audited financials.

Asset sales – could come in below expectations.

Catalyst

Catalysts:

Audited financials

Further catalyst will be increased visibility to non-core asset sales progress

Lower financing costs