Description

Global Net Lease (“GNL”) and Necessity Retail REIT (“RTL”) are two externally managed REITs coming together in an all-stock transaction where the external manager, AR Global (“AR”), plans to internalize the management structure and in turn, remove a massive overhang over the shares. GNL will issue 0.67 shares of GNL for each common share of RTL, leaving GNL as the remaining entity. On a pro forma basis, giving GNL credit for synergies (of which the majority is the elimination of the management fee) and factoring in the dilution from issuing shares to both AR and Blackwells Capital (“Blackwells”), the shares are trading at 6.0x P/AFFO on 2023 v the externally managed peer group average of 14.6x and will have a dividend yield of 14.1% v group average of 5.6% (see comp sheet below). While I don’t expect this name to trade in-line with the group, there is nearly 60% upside using P/AFFO and more than 90% upside using a dividend yield valuation approach even assuming it trades at the lowest multiple in the comp group.

Background:

GNL and RTL are the largest REITs within the AR global external manager complex. For those not familiar with AR Global, think of them as the ugly stepsister of RMR. VIC message boards are full of body bags associated with investing in the RMR complex. In essence, they were both externally managed REITs where I believe the incentives were simply not aligned. AR Global was the management company behind both with a clear incentive to grow for the sake of growing. Therefore, I believe this has been a very destructive business model over time as both companies would dilute equity holders to buy assets with complete disregard for ROIC/shareholder returns. In fact, AR had very little economic interest in both equities and most of the compensation was paid in the form of a management fee; hence one could argue that AR does not care as much about the share price as they do about overall gross real estate value. In general, many institutional investors have stayed away from these types of companies which helps explain why externally managed REITs trade at a significant discount (could be 50%+) to internally managed REITs.

In the Fall of 2022, Blackwells Capital took a position in both entities with the hope of running a PROXY fight to overthrow the Board of Directors (which was mainly controlled by AR), remove the external manager, and align interest with shareholders. To summarize, Blackwells Capital’s presentation titled “The Case for Change” on 4/25/23, showed just how destructive this structure has been. To quote from the presentation, “Since 2015, AR Global collected a jaw-dropping $838 million dollars in fees and expenses from GNL and RTL, while the market capitalization of these companies has gone down by more than $3.3 billion dollars.” Just as it looked like Blackwells was on their way to a well-deserved victory, GNL and RTL announced a merger on 5/23/23 whereby they would remove the external manager in exchange for significant ownership in the pro-forma entity. At the time of the announcement, Blackwells came out against the merger given that AR Global was being compensated ~$375mm for internalizing the management company (a simple change of control would have netted them ~$150mm-200mm), but quickly backed the deal in early June when they reached an agreement.  This agreement compensates Blackwells with ~$20mm in new shares for “consulting and advisory.” I didn’t know i-banking paid this much. Interestingly, a few weeks later (June 15^th), another investor, Orange Capital, released a public letter pleading with shareholders to strike the deal down given the asinine payment to AR and the hypocrisy of Blackwells. Orange argues that GNL should look to internalize the manager as a stand-alone company (more below, but one can dream).

Ultimately, I believe this combination will save $51mm of annual expenses at the onset associated with “asset management fees, property management fees, incentive fees, equity issuance fees, and reimbursable expenses net of internalized employee compensation, rent and overhead, and retained 3rd party services” (source: GNL investor presentation 5.23.23). Post close, pro forma ownership will be ~45% GNL, ~39% RTL and 17% AR Global.

GNL will become the 3^rd largest net lease REIT globally with nearly $10bn of gross book value of real estate, only behind the ~$44bn at Realty Income and ~$19bn at W.P. Carey (source: slides from management merger presentation below). This compares favorably to the group average of ~$5bn. The combined entity will have 1,396 properties covering 67.1mm square feet with approximately 96% leased (source: management presentation). The new GNL will have a more diversified book of tenants with top 10 tenant concentration of 19%, making the company one of the more diversified triple net lease REITs in the industry. While some REIT investors prefer REITs to focus on one industry or vertical, I believe that the diversification by asset class and geography makes this one of the more defensive REITs in the market.

What should it be worth?

I believe this deal is transformational as it addresses a lot of the issues that institutional managers have with externally managed REITs. First, AR Global will now be fully aligned with minority shareholders given their ~17% stake in the company. They will no longer be paid a management fee and like the rest of us, will be focused on total shareholder return. Second, the combined company will be co-led by the GNL CEO Jim Nelson and the RTL CEO Mike Weil. However, Mike Weil will be taking over as full time CEO in early 2024. As part of this merger, Mike will be stepping down from other AR Global CEO positions, mainly his role as the CEO of HTI and ASIC. He will also no longer have a day-to-day operating role at AR Global due to his employment contract at GNL. Third, GNL is addressing concerns surrounding board of director independence by hiring three independent RTL directors. The board will be majority-independent with an independent chairman.  Fourth, the board will be declassified so 7 directors stand for election at the 2024 meeting and all 9 would stand for election in the 2025 meeting. Moreover, the company opts out of MUTA (“Maryland Unsolicited Takeovers Act”) which would allow them to re-classify without shareholder approval. Ultimately, this now makes the company much more appealing to a broader institutional investor base, given there is only one share class.

In assessing valuation, I looked at all the externally managed REITs. The positives that GNL has going for are a) low tenant concentration making it more “defensive”, b) 3^rd largest externally managed REIT helps with broader diversification. The negatives are a) higher leverage and b) lower occupancy rate. The neutral KPIs are a) dividend coverage (they are in the bottom 1/3^rd), b) industry exposure and c) AFFO growth (this one we are disregarding because historical growth rates are not indicative of strategy/motivation going forward). Regardless, I laid out a simple framework below. I think that at the very least GNL should trade at or slightly below the multiple of EPR Properties (“EPR”). EPR is arguably the worst exposed REIT with >40% exposure to theaters. Regardless, even at or slightly below EPR’s multiple, GNL is worth anywhere from $15-$20 depending on whether you use an AFFO multiple or a dividend yield to set its intrinsic value.    

Source: Internal Analysis, Bloomberg

Source: Source: Bloomberg, JPM Comp Sheet

Let’s address the pushbacks:

I don’t invest in externally managed REITs and even though they are turning into an internally managed REIT, there may be  a significant discount due to AR Global in the future.  However, that statement is backward looking. One can’t simply judge AR by its past digressions. AR Global was doing what anyone with the same motivations would do. They grew for the sake of returns because they were incentivized to do so.  I believe they were in fact acting 100% rational given their compensation structure. That is changing now. In fact, AR is giving up $51mm a year in management fees and their motivation is even greater now to create shareholder value. They can only do that if the share price goes higher. At this point, the alignment and the motivation is already there and therefore intrinsic value comes down to simply the value of underlying assets.

When looking at the financials, I am concerned with ____ (fill in the blank)? I think the comp sheet and the prior section addresses the ways these guys screen poorly vs the group. We can debate how many turns of discount the leverage is worth. However, I don’t think that debate really matters until the stock is $15+. At that point it will still be the lowest multiple in the group and we can discuss if that is warranted or unwarranted.

Isn’t AR Global again taking advantage of shareholders with their fee to internalize the management company?  Yes. It would have been great if they only settled for $150-200mm, but it is what it is. This equity payout is factored into the dividend per share and AFFO per share. Going forward, they will be fully aligned so that we no longer have to worry about the prior misalignment of incentives. Ultimately, I would rather AR get its inordinate fee and the merger be consummated than these companies remaining externally managed REITs.

Isn’t Blackwells getting overpaid?  I think so but I do not believe this has any bearing on the path going forward.

Are they not better off internalizing themselves and going at it alone?  Yes, and this is what Orange Capital is arguing, but I do not think this is a realistic option. In an ideal world, GNL calls off the merger, announces they will internalize and go at it alone, saving a lot of money being paid to AR Global. However, for that to happen, shareholders need to vote the deal down, replace the board and then have the new board make this decision. Ultimately, I do not expect this to happen given what has transpired. 

Disclosure: At the time of publication, the author of this article holds a position in GNL.  This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  Any projections, forecasts and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

Catalyst driven by closing of merger and removal of external manager