Description

Despite being one of the largest office landlords in the US, with quality properties and a geographically diverse portfolio, Trizec Hahn has lagged its peers. This has been attributed to three issues: an inappropriate corporate structure; the European development strategy, and the company’s technology diversification initiatives. Despite its terrific US properties, and the fact that most US real estate companies are structured as REIT’s, Trizec Hahn retained its corporate structure and low dividend payout, reasoning that it could utilize the cash flow more effectively, and yield higher growth instead. Unfortunately, in practice, this did not work out, as Trizec blundered into ill-starred technology investments, and an unrewarding European diversification initiative. Finally, its corporate structure kept it from being included in many REIT-based real estate indices. The stock price has languished as a result.

In an effort to close the valuation differential between itself and its would-be peers, Trizec has proposed a restructuring. It will exit all non-core assets, dividend out to Canadian shareholders its remaining interest in Europe’s Global Switch, and adopt a US REIT structure. The restructuring itself is rather complicated and has likely put further pressure on the stock as many shareholders sell what they can’t understand.

Since it is a Canadian company morphing into a US REIT, Trizec will split itself into two economically equivalent parts. The US properties will be owned by TZH REIT, which will be a publicly traded US REIT, likely symbol, TRZ. The remaining non-core properties in Canada and Europe will be owned by Canco, a publicly traded Canadian corporation. Canco will also hold 40% of the stock of TZH REIT. US shareholders will receive TZH REIT shares on a 1:1 basis; Canadian shareholders shares of Canco on a 1:1 basis.

If you’re still with me so far, let’s explore the next layer of complexity. Morphing into a US REIT from a Canadian real estate corporation would subject TZH to a 35% US capital gains tax under the Foreign Investment in Real Property Tax Act, affectionately known as FIRPTA. However, under the current proposal, FIRPTA would not be triggered if TZH REIT were to qualify as a domestically controlled REIT. TZH REIT meets this requirement when less than 50% of its stock, by value, is held by Non-US persons. The current proposal accomplishes this, and proposed future ownership restrictions are designed to keep the non-US ownership under this threshold for the 5 years necessary to permanently avoid the FIRPTA.

Did I also mention that TZH properties are mostly office buildings, of which there is a glut? Everyone “knows” that the office building business is going to be under pressure for a long long time.

OK. We’ve got a complex restructuring, with a potential tax trigger hanging over a company in a distressed sector. Why am I wasting your time?? Because there is Value here. Shareholders sell what they can’t understand, particularly if the previous experience has been disappointing. If everyone “knows” the office building sector is going to be in the dumps forever, then this pessimistic outcome is likely already priced into the stocks. We can see this with the discounts to NAV. Most stocks in REIT-land are trading at or above NAV. As of March 15, the average Office building REIT, at a 6.4% discount. TZH trades at a 27% discount to NAV. Additionally, since TZH is paying the low dividend thru the end of 2002, the NAV will grow by another $2.

With the conversion to REIT status, and its incumbent mandatory payout of 90% of earnings, the 2003 dividend is scheduled to be in the $1..30-1.45 range. Using 1.38 on a $16 stock yields 8.6%, a significant premium to the 6.2% of comparable office reits.

The complexity issue will soon soften somewhat, with the Apr23rd s/h meeting, and early May scheduled close. US s/h’s will receive only the TRZ REIT shares; nice and clean. This should help erode the NAV disparity. Additionally, management has really guided down expectations, and this is reflected in the stock price. This may present an opportunity; for TZH may be able to negotiate a relatively small FIRPTA payout based on this low equity valuation, and thus remove the FIRPTA issue and the non-US shareholder restrictions. I just get the sense that this may be what management is doing, and successfully pulling this off would add $2-3 to the share price immediately.

Lastly, there has been a steady movement of investment into REIT’s. This has been the result of a movement out of equities, and consolidation in the REIT industry. This consolidation has provided more professional ethical management, and larger liquid entities in which pension funds etc can put large amounts of capital to work easily. TZH REIT should be one of these vehicles, and will likely get included in several REIT indices, resulting in passive buy-and-hold investors.

Catalyst

Impending Reorganization, scheduled to be implemented around May 8th.