Morguard Corporation MRC CN
April 25, 2008 - 12:27pm EST by
lindsay790
2008 2009
Price: 32.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 453 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Morguard Coporation: BUY
(Ticker: MRC CN; Recent Price: $32.50; Market Cap: $452.6 mm)
Even in a difficult environment for commercial real estate, a real estate company trading at 7x free cash flow stands out as a spectacular value. You would be surprised to learn that this company is not a niche player but rather one of the largest integrated real estate companies in Canada.
Morguard Corporation (“MRC”) owns or manages nearly $9 billion of Canadian and US office, retail, residential and industrial real estate assets spanning more than 42 million square feet. Despite the size of its operations, MRC remains relatively unknown to investors as it has almost no research coverage and does no investor calls or presentations. The CEO and owner of approximately 45% of MRC, Rai Sahi, is a self-made entrepreneur known for finding value in underperforming companies or assets.
MRC recently announced its intention to offer to buy in the 27.4% minority interest in Revenue Properties (“RPC”), one of its operating subsidiaries. We believe that this transaction will simplify MRC’s financial statements and make the value of the company more readily apparent. More importantly, we believe this transaction is another shrewd move by Rai Sahi to add shareholder value. He is taking advantage of the weak market for real estate equities to buy the minority interest in RPC at a 10.7% trailing cap rate and for 6.9x its 2007 funds from operations (FFO), a massive discount to its peers at 7.3% and 12.7x.
We believe that MRC trades at more than a 50% discount to intrinsic value based on the FFO multiples and adjusted funds from operations (AFFO) multiples of comparable companies. It trades 5.0x 2007 FFO and 6.9x 2007 AFFO (pro forma the RPC transaction) versus its peers at 12.7x and 14.8x respectively. At these market multiples, MRC would trade at $82 and $69.
Company Overview
MRC conducts most of its business through five wholly and partially owned subsidiaries.
It has two fee-based subsidiaries.
· Morguard Investments (“MIL”)(100% owned) – MIL is a real estate investment advisory and management services business serving major institutional and private investors. It had $7.5 billion of assets under management as of 12/31/07.
· Morguard Financial (“MRF”)(100% owned) – MRF provides portfolio management services specializing in real estate equities and income-producing investments. It had ~$200 million of assets under management as of 12/31/07.
MIL and MRF together generated more than $17mm in fee income in 2007 after producing less than $10 million in 2006 as MIL increased its assets under management by 15%. We believe these businesses are overlooked at MRC as they generate less than 15% of its EBITDA. However, similar business garner more than 8x multiples.
MRC has three subsidiaries that own commercial properties.
· Morguard REIT (“MRT”)(41.9% owned) – MRT is a publicly traded real estate investment trust (MRT-U CN) with ~$750mm market cap that owns Canadian office, retail and industrial properties. It has recently sold the majority of its industrial properties to redeploy capital into office, retail and mixed-use properties. It currently trades at a slight discount to its peer group at 11.1x (vs. 11.9x) and 13.5x (vs. 14.0x) 2008E FFO and AFFO despite a similar modest growth profile to its peers. MRC’s investment in MRT was consolidated until the fourth quarter of 2006. Since then, it has been accounted for using the equity method. MRC purchased shares during January 2008 to increase stake to 42.8%.
· Revenue Properties (72.6% owned) – RPC is publicly traded real estate company with ~$130mm market cap that owns retail, residential and office properties in Canada and the US. It entered the US market in late 2006 with the acquisition of Sizeler Property Investors, which doubled its net operating income (NOI). Sizeler owned retail and apartment properties on the Gulf Coast. The properties were poorly managed allowing RPC to buy them at a discount to market and take advantage of opportunities for better property management. Both the Canadian and US businesses have shown stable growth since the acquisition. MRC recently announced an offer to purchase the remainder of RPC for $12 in cash or 1/3 of share of MRC per RPC share. We believe RPC to be worth approximately double the $12 per share cash offer.
· Morguard Residential (“MRES”)(100% owned) – MRES owns 7,000 apartments and manages an additional 3,000 apartments in Canada.
In addition to these operations, MRC directly owns several non-residential assets including three office towers and a stake in a shopping mall in Ontario. MRC’s wholly owned properties (including RPC’s properties) produced $256.1 million and $140.9 million of revenue and NOI in 2007.
Valuation
MRC could be evaluated versus its peers based on its FFO and AFFO multiples or as a sum of four parts (Morguard REIT, the fee-based businesses and the consolidated properties). Either way, MRC’s market value vastly understates its intrinsic value.
Comparable Company Analysis


FFO Multiple AFFO Multiple


2007 2007




MRC Multiples 5.0x 6.9x




Canadian Diversified REITs/Property Companies(1)
Averages
12.7x 14.8x
Min
11.2x 12.9x
Max
15.1x 18.0x




MRC FFO and AFFO per Share(2) $ 6.49 $ 4.68




Implied MRC Price at Averages $ 82.11 $ 69.16


(1) Source: RBC Capital Markets. Companies include Allied Properties REIT, Brookfield Properties, Calloway REIT, Cominar REIT, CREIT, Dundee REIT, First Capital Realty, H&R REIT, InStorage REIT, Morguard REIT, Primaris Retail REIT and RioCan.
(2) Calculations below:
Reported FFO
92,523
Interest @ 6% on Incremental Debt
(2,139)
for RPC Minority Interest Purchase

Pro Form FFO
90,384
Shares
13,925
Pro Form FFO per Share
$ 6.49

Pro Forma FFO
90,384
Maintenance Capital Expenditures
(16,300)
Deferred Leasing Cost Additions
(1,081)
Stepped Rent Adjustment
(2,011)
Amortization of Below Market Leases
(5,814)
Pro Forma AFFO
65,178
Shares
13,925
AFFO per Share
$ 4.68

Sum of the Parts
We would conservatively value MRC’s 41.9% stake in MRT at market ($315.6 million) despite MRT’s trading at a slight discount to peers. We would value the fee income using the average EBITDA multiple of public property management companies. Then, we would value the current consolidated revenue producing properties using the average cap rate of Canadian commercial REITs and property companies. Finally, we would value all other assets and liabilities at book value.
Comparable Fee-based Real Estate Company Analysis


EBITDA Multiple


2007



CB Richard Ellis 8.1x
Grubb & Ellis 11.1x
WPCarey
8.4x



Average
9.2x
Min
8.1x
Max
11.1x



MRC Fee EBITDA 17,626



Implied Value at Average 161,865

Comparable Canadian REIT/Property Company Cap Rate Analysis


Cap Rate


2007



Canadian Diversified REITs/Property Companies(1)
Average
7.3%
Min
6.0%
Max
8.3%



MRC NOI
140,865



Implied MRC Revenue-Producing Property Value 1,936,894
(1) Source: RBC Capital Markets. Companies include Allied Properties REIT, Brookfield Properties, Calloway REIT, Cominar REIT, CREIT, Dundee REIT, First Capital Realty, H&R REIT, InStorage REIT, Morguard REIT, Primaris Retail REIT and RioCan.
Sum of the Parts
Morguard REIT at Market
315,620
Fee-based Business at Average of Comps 161,865
Properties at Average of Comps
1,936,894
Net Debt(1)

(1,124,623)
MRC Equity Value

1,289,756
Shares


13,925
MRC Equity Value per Share
$ 92.62
(1) Pro forma for $35.7 million for the purchase of the 27.4% minority interest in RPC. Calculation of net debt below:
Debt


Mortgages
1,096,247

Notes Payable
29,587

Construction Financing
-

Converts
-

Bank Debt
178,079




Total Debt
1,303,913




Cash
29,644
Restricted Cash
331
Mortgage and Loan Receivables
40,964
Assets Held for Sale - Net Liabilities
-
Land for Development and Sale
16,635
Properties for Development
31,776
Investments
52,913
Investment in Direct Financing Lease
7,027
Total Cash and Non-Revenue Producing Assets 179,290




Net Debt
1,124,623
Issues
  • Taxes. MRC is not a REIT; it pays corporate level taxes. As a result, making comparisons with REITs is complicated. We realize that accounting for taxes should mean that our valuation be discounted. Any discount would have to make assumptions concerning when (or if) taxes would be paid (e.g. MRC does not expect to pay US taxes in 2007 because of high levels of interest expense and amortization) and the tax considerations of the investor.
  • The Commercial Real Estate Market. The recent weakness in the North American commercial real estate market could continue increasing the cap rates of properties and lowering the multiples of public commercial real estate companies. However, we note that Canadian property values did not escalate nearly as much as US property values from 2002 to 2006.
  • Liquidity. MRC’s shares trade rather infrequently. We think the discount to fair value on the shares more than makes up for this.
  • Potential Conflict of Interest. MRC owns a 42.8% interest in MRT, and the two companies share a CEO.
Catalysts
  • Completion of the RPC transaction
  • Earnings reports with steadily increasing book value
Bottom Line
The market does not know that this company exists based upon its massively discounted valuation as compared to peers. MRC has produced solid results in the past, and there is no reason to believe it will not continue to do so in the future. Management takes a disciplined approach to acquisitions and dispositions to their portfolio and have a growing fee-based property management business. We recommend potential investors visit www.morguard.com to see the extensive market-by-market and sector-by-sector forecasts and overviews put out by the management team.

Catalyst

* Completion of the RPC transaction
* Earnings reports with steadily increasing book value
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