Description

Overview
Killam is a compelling long opportunity. The Company acquires, re-develops and manages multifamily residential properties and manufactured home communities (MHC) in the urban areas of the Atlantic Canada region (New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland). As of September 30, 2005, the Company has 10,094 total units comprised of 5,900 apartment units and 4,194 MHC pads (land under an MHC) 2005. As of December 22, 2005, the Company has announced acquisitions that yield a total of 11,366 units.

Killam has been aggressively acquiring apartment buildings and MHCs throughout Atlantic Canada and Ontario over the last several years with little competition. As a result, the Company has been able to acquire units and pads at attractive cap rates (8-10% on the apartment side and 9-11% for MHCs) and finance the purchases at low costs of fixed rate debt (weighted average cost of 5.6%) typically using a loan to value of 75%. Overall occupancy levels are 97%.

The company plans to finish consolidating the region (a new goal of 10,000 apartment units and 10,000 MHCs was recently put in place vs. the previous goal of 10,000 total units) and either sell the company or convert to a REIT within the next 2-3 years. Each of the two divisions is set up as a REIT under the holding company in order to maximize the ease of converting Killam to a REIT. Once the heavy lifting is complete, the Company will have created significant value for its shareholders. The Chairman helped execute a similar acquisition strategy for Boardwalk (BEI-UN CN) in Western Canada that resulted in Boardwalk stock increasing from $2 to $25 between 1995 and 1999. The management team has worked in the Atlantic Canada real estate industry for many years and has been able to execute deals utilizing long-standing relationships and with little competition (the majority of the deals are never put up for bid).

The Canadian public REITs have very little exposure to the Atlantic Canada region (collectively only 2.1% of their total units) and are seeking to expand their presence via decent sized portfolio purchases. Killam has an ample amount of likely buyers (public REITs such as CAP REIT (“CAR-UN CN), Northern (“NPR-UN CN”), and Boardwalk (“BEI-UN CN”), pension funds and possibly U.S. based REITs).

Killam trades at a significant discount to its future NAV/share, comparable Canadian REITs using forward FFO multiples (all of which trade at a significant discount to US public REITs). A REIT conversion would make the disparity greater. The CFO believes he could sell the entire company today at a 7-7.25% cap rate but the long opportunity is still compelling at higher overall cap rates. Recent cap rates in Vancouver have been sold in the 4%-5% cap rate range and have poorer vacancy rates than Killam’s properties.

The Company has acquired properties in clusters thereby spreading operating/personnel costs across many buildings. The Company has been hesitant to raise rents since many of the acquisition targets in its pipeline are located directly across the street from recently acquired properties. Raising rents will lift the local market and thus drive up acquisition costs.

MHCs
Killam owns the land and rents it out to the tenant who owns the house. The tenants hook up their houses to the communities’ plumbing, electricity and water systems. In Canada, MHCs are essentially permanent housing. Typically, when a home-owner vacates the community, he or she sells the house vs. using an 18-wheeler to tow it away. As a result, vacancy rates are extremely low (0.8%) and the cash flows are stable. As of September 30, 2005, Killam owns 4,194 MHC pads with an average rent of $197/month. The annual MHC maintenance capex required by Killam is roughly 1-3% of sales (plow/maintain roads, plumbing maintenance etc…). NOI margins are 65.0% for the first nine months of the year. There is little competition in Canada to acquire MHCs (especially in Atlantic Canada) and the Company has been able to build up its portfolio of pads at 9-11% type cap rates. Parkbridge (“PRK CN”) is a public company in Canada that is also consolidating the MHC market. In talking with the CFO, its possible that a REIT spin-off occurs in the next few years and/or Killam executes some sort of combination with Parkbridge. MHCs constitute roughly 20% of the firm NOI for the first nine months of the year. The Company has also been looking for acquisitions outside of Atlantic Canada on the MHC side of the business.

Multi-Family Apartments
As of September 30, 2005, Killam owns and operates 5,900 apartments. The apartments have 57.8% NOI margins for the first nine months of the year. The apartment properties currently are operating at a 4.7% vacancy rate and have an average rent of $683/month. Capex is typically 5-8% of sales. The Company has been able to build up its portfolio of apartment units at 8-10% type cap rates.

Management/Ownership Highlights
Phil Fraser, the CEO has experience in the development and financing of real estate in Atlantic Canada. Rob Richardson, CFO is a former co-owner of a real estate brokerage and property management company – (properties included 3,500 multi-residential units). Rob also owned a regional real estate brokerage firm in Atlantic Canada. Management/Board own 11% and Third Avenue is the largest outside holder with just under 9% ownership.

Financing
The Company raised $57MM in May of this year using a combination of equity (6.0MM shares at $2.55) and 6.5% convertible debt (converts at $3.10 at any time after May 2007). Brascan Financial Corp recently upped and extended the duration of its acquisition facility. The Company will unlikely sell stock below $3.50/share and will first utilize its 2 year Brascan line and free cash flow, increase leverage and refinance existing properties before doing another equity offering (especially at these levels).

The Company is currently meeting with rating agencies and ideally would like to execute on a pure debt offering once they get rated vs. issuing equity. One knock on the company is that they have been a bit conservative as far as leverage goes but in my latest conversations with the CFO, he seemed more convinced that additional leverage was the right plan of action.

Market Trends
Macro trends in the Atlantic Canada region are very positive given the oil and energy exploration initiatives impact on job growth/local economies. Favorable vacancy trends and rent increase trends in its markets have been independently forecasted. Energy related, government (4 provincial capitals in the Atlantic Canada region), call center and university type jobs are in its markets. There is no significant rental construction occurring in its core markets. Rents have been steadily increasing in Atlantic Canada since 2000. There are 87,700 rental units in Nova Scotia, New Brunswick, Prince Edward Island and Newfoundland.

Other
The Company has been hurt a bit by the rise in oil. There is no oil issue on the MHC side of the business or on roughly 24% of the apartment properties where the tenant pays for utilities. The rest falls on the company (I estimate that oil increases impact roughly 60% of the units contributing to overall NOI). By year-end 2005, Killam expects to have 50% of its apartment units heated by oil and 27% by natural gas). The Company has been swallowing some of these cost increases because it has been reluctant to increase rents in its markets. The Company has typically been acquiring properties right next door to eachother so any rent increases in the market would increase the purchase price of its targeted acquisition base. The company has now achieved a size and pipeline where its just starting to raise rents in its units and thus should improve NOI margins on the apartment and MHC side of the business. They have also put some hedges in place.

Interest rates are rising and this will compress ROEs but the value creation is still there using higher cap rates and dividend yields under a REIT structure as long as they execute the acquisitions (which I’m fully confident they will continue to do). The Company has substantial room to grow in its markets and remains a small percentage of the Atlantic Canada market. According to management, the pipeline remains extremely strong.

Killam recently announced an agreement with a telecommunication company which should provide some juice to the margins. The Company may start to offer some furnished suites (higher margin) in certain properties as well. The Company has some undeveloped land it attained in certain of its acquisitions. Killam will likely develop or sell the extra land to yield additional apartments and MHCs or non-dilutive cash to fuel additional acquisitions.

Given the acquisition pipeline and market opportunity, free cash flow generation, refi opportunities, excess land value, Brascan line and success in completing financings, I’m confident that the Company will be able to favorably finance its acquisitions goals.

Valuation
U.S. apartment REIT valuation multiples are significantly higher than Canadian REIT multiples. For Killam, I get 2006 FFO/Share of around .27 cents. At current prices that’s roughly 10.7x '06 – the Canadian comps trade at 14.4x ‘06. For Killam, I believe '07 will be around $0.34 of FFO/Share and that implies an 8.5x multiple at current prices – the Canadian comps trade at 13.1x ‘07. A reasonable multiple on Killam yields a $4.00+ stock price.

Assuming Killam converts to a REIT in 2007 and using a 7% yield (conservative relative to the comps) would also yield a $4.00+ stock price.

Management has stated it believes it could sell the portfolio at 7-7.25% type cap rates. Using a 7.75% cap rate on year end 2006 gives an NAV/share of almost $4.00.

Acquistive REITs in Canada have paid lower cap rates for portfolios of this size when diversifying into new geographic areas. The current stock price for Killam is just too cheap for a now decent sized, strategically valuable collection of assets.

Catalyst

Continued execution of acquisition plan
Favorable financing
Conversion to a REIT (in next couple of years)
Spin-off combo with Parkbridge
Sale of the Company