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Newcastle Investment Corp. (NYSE:NCT)

Q2 2014 Results Earnings Conference Call

August 7, 2014 10:00 AM ET

Executives

Sarah Watterson - Investor Relations

Wes Edens - Chairman

Ken Riis - Chief Executive Officer

Justine Cheng - Chief Financial Officer

Analysts

Chas Tyson - KBW

Matthew Howlett - UBS

Operator

Good morning. My name is Tony, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newcastle’s Second Quarter 2014 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Sarah Watterson, you may begin your conference.

Sarah Watterson

Thank you, Tony, and good morning, everyone. With me today from management, I have Wes Edens, the Chairman; Ken Riis, the CEO; and Justine Cheng, the CFO. Throughout the call, we are going to reference the supplement that was posted to the website this morning. So if you haven’t downloaded it, I would suggest you do so now.

And briefly before we start the call, we just want to remind you that statements made today may be forward-looking statements. These statements, by their nature, are uncertain and may differ materially from actual statements. We encourage you to read the forward-looking statements in our supplement as well as the risk factors on Newcastle’s 10-Q.

I would also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any securities. And finally, the webcast and audio cast is copyrighted material of Newcastle and cannot be duplicated, reproduced, or rebroadcasted without our consent.

With that, let me turn it over to Wes.

Wes Edens

Great. Thanks, Sarah. Welcome everyone. I am going to refer to the supplement that we have posted, and we’ll put through here just in the next few minutes. Maybe, we’ll start with page two. Just as a reminder, on the schematic here as to what Newcastle is today, because we are in the middle of the transformation with the pending spend.

So if you look at the chart. The green box, our New Senior business, which we’re in registration now at the SEC, $700 million of capital deployed, been a very robust quarter for us. We invested $199 million in senior housing properties. The organic performance was terrific, I will talk about all that in a second.

The right hand box, the Real Estate portfolio, also very active quarter, $174 million in liquidations. Ken, will talk about that. We basically were able to make all of our investment activity on the left hand side funded with internal funds, and on the right-hand side, which is what the goal was, so we are happy about that.

Underlying performance of the debt portfolios continues to improve, and then our newest investment in the Golf business, we have got some good news on, and it has been a slow but steady quarter there as well.

So page three, highlights just to start, very important. As I mentioned, $199 million of capital deployed to the senior housing that brings our total portfolio up to $1.8 billion, $700 million of invested capital, over $1 billion in the pipeline including $130 million in assets in contract that we expect to close soon, and all of this done while internally self-funding.

We realized $174 million return of capital from asset sales, paydowns, financing, et cetera, average price of over par, so that’s a very good quarter, in deed, $36 million in net gain on sale. So, happy with both liquidity and the performance there.

And then the last is the Golf. We hired a manager to help supplement the management team that we bought along with the company and very good initial results on that, and I will talk about that in a just a few minutes.

So that’s page four, the financial review. Core earnings, $0.09 per share, $0.10 of gain from the liquidation of the properties, $87 million in cash, so we had a substantial cash position that would have added to the core and brought it up to approximately the $0.10, paid a $0.10 dividend, so a steady and expected performance from a financial standpoint.

Page five, the spin-off timeline, the good news is that it continues to move very much at pace with our expectations. We have done this before obviously, and our experiences have been that from the time of a filing until the time that it actually ends up being free to trade, it is difficult to predict in every case, but my rule of thumb is 120 days is kind of what I expect. We filed back in June, so 120 days from then would be in the middle of October, and I think that based on what we see right now, we feel like we are much on track for that.

We are in dialogue with the SEC and on comments right now. We have segment reported this portion of our new portfolio for a year now, so we had good experience in terms of breaking out the financial and disclosure reporting for it, so we feel like we are very much there.

This is the big exciting news for the company. We are looking forward to having a big, robust, standalone senior housing company. We think that that’s a big event for shareholders. It could be a big incremental dynamic for us, that’s great.

And with that, let’s flip to the next section and talk about senior housing for a second. Page seven, here is the map of the U.S. with the dots representing both our managed properties, the ones we manage ourselves through Blue Harbor in green and the triple-net leases in blue.

Our goal [loosely] is to end up with a portfolio that’s managed, kind of 50-50 between the two. We think that that’s a good mix in terms of the risk and return of the portfolio. It’s not a precise thing to manage towards, but it is something that I think in broad strokes will give us a good risk return profile.

Right now, we’ve got 41% of our portfolio invested in managed properties, 59% in triple-net leases. The portfolio is a very attractive one. 95% private pay, it’s a good mix of the managed and triple-net portfolios, and we’ve have got good clustering, which has been an important aspect of performance for us we found over years when we look at the map.

Page eight, the financial performance, very, very good performance. The managed same-store portfolio generated a 24% property level leveraged yield in the second quarter versus 13% pre-acquisition. Our plan was to buy properties, improve the performance, and so far so good on that portion of our portfolio.

The triple net, obviously, we’re locked into a lease rate. It’s got lower risk, but it also has lower returns. That’s the mix that we think is really attractive. If you take the two of those in combination, we have a total return that’s circled in green there, 15% across the portfolio.

So in a market where the yields for these kinds of companies trade in the mid-single digits, we think we have achieved a terrific result for shareholders. Once again, once we get this company spun , we think we will get a real benefit for that in terms of evaluation.

Page nine, this is the chart we’ve used many times, I want to reiterate as well, in that the dynamics of the market continue to be very much what we would like. The plus 70 U.S. population is the fastest growing cohort of the U.S. population, and yet the industry itself is characterized by still a significant supply/demand imbalance and high fragmentation, lots and lots of the properties managed by the “mom and pops,” people that manage 10 or fewer properties. That green part of the pie chart is what we view to be our target for our managed portfolio in particular.

Page 10, the market for us has been very robust. So, to-date just to reiterate, $1.8 billion in investments we have made. We have another $130 million in contract that we expect to settle in the very near-term, and we have an additional pipeline of $700 million of which we think a good chunk of that is actionable.

So, we feel terrific about where we are right now in the pipeline, and there is a lot of competition for these assets, there is a lot of capital that’s been form, but again we have been in the business for 15 plus years. We feel great about our position of it, and are very happy with where we are.

So, with that, Ken let me turn on the debt side.

Ken Riis

Sure. I will talk about the real estate debt portfolio starting on page 12, but before I get into some of the details, I just want to -- the three things I want you to take away from the call today that I want to highlight.

First is that, we had a very active quarter. We sold some of the portfolio raising $174 million of capital for reinvestment. The fair value portfolio continues to improve, and I think there is still upside going forward, and the portfolio is still large, its $700 million face amount of assets in size, and we still expect to recover $350 million to $400 million of principal recovery over time.

So if you look at page 12, we’d start out with the activity for the quarter. We are very focused on maximizing recoveries, and timing of asset sales is part of our strategy. So in the quarter, we recovered $174 million of capital for reinvestment as a result of three things.

First, we sold $345 million of assets at an average price of $102.5 million. We’ve also received $50 million of asset pay downs in the quarter, and the last thing we did is we put about $26 million of new financings against CDO VIII direct holdings that we hold on our balance sheet, so a pretty active quarter, and we raised a lot of capital for reinvestment.

On Page 13, I just want to give you a quick overview of the portfolio. We have -- really the second quarter marked the 10th consecutive quarter of the price increase of the portfolio on a same-store basis, so 10 consecutive quarters of price increases in the portfolio that we own today.

In the quarter, the price of the portfolio was up 1.4 points, ending at about 78% of par, and I believe there is upside from here. We ended with $860 million face amount of assets, financed with $450 million of third-party debt, and our expected recovery going forward is $373 million, so still a lot to come.

Page 14 is a new page that I think would be helpful for everyone. What we’re trying to show here is, sort of, based on the activity in the second quarter, what our expected recovery looks like quarter-over-quarter. We’re going to do this going forward. So, it’s easy to track our activity and performance, and I think it’s helpful for shareholders.

So if you look, we started the quarter with $543 million of expected principal recovery. And with our activity in the quarter, we ended with $373 million of expected principal recovery if we hold our portfolio to maturity.

Page 15 is something we’ve been showing you every quarter, but what I’d really like to highlight is it does change quarter-over-quarter, and really what I want to show here is what’s highlighted in green is what we own at Newcastle of both portfolios. So, these two deals, CDO VIII and IX are meaningful to us.

We have $800 million of assets held within these two CDOs with only $300 million of third-party debt. In the past, we bought back a lot of CDO notes, and as a result, the leverage has come down. What that also means is that as assets prepay or we sell, we’re going to have meaningful recoveries. And in these two portfolios alone, we expect to recover about $350 million over time.

So to conclude, it was a very productive quarter. Our portfolio is positioned well, and I think there is meaningful upside from here.

I’ll pass it over to Wes.

Wes Edens

Great. Let me just briefly touch on the golf portfolio. It’s the new asset [class four] of the Newcastle. So I just again want to reiterate what of those we actually own. Page 17, the map you can see that we own or lease a total of 90 properties across the United States but heavily concentrated on the west coast and then down in the southwest.

We are the third largest operator, fourth largest owner of golf courses. Golf courses are highly, highly fragmented ownership. It’s even more so than on senior housing side. We own both public and private courses or own private and managed public courses, in particular have these concentrations that we love doing in Southern California and in Texas.

On page 18, the performance of the portfolio so far has been very much on plan and has done well. So revenue increased 4% from $140 million to $145 million. Adjusted EBITDA grew $6 million in the period from $12 million to $13 million, again just to kind of give context to the capital structure that we have invested in. We have a total of $79 million in capital invested.

There’s a $150 million in debt. So the total capital stack is $229 million. Our expectations for EBITDA for the year is about $26 million. And we think that the upside with the management team that we brought in is something in the low 30s.

So again if you look at from a public market comp, the Club Corp folks traded at about 10 times multiple. So where we’re right now, we feel like it’s a very compelling evaluation and with some incremental growth from here we think that we can take it to a place where we will have a very, very substantial return on our investment.

Page 19, the opportunities for growth as I mentioned, is a highly, highly fragmented market. 97% of the industry is owned by mom & pop. So we are the owner of 90 -- manager of 90 properties out of approximately 15,000, so not a high percentage in the overall market yet we’re the third largest manager in the sector.

So there’s a tremendous amount of growth. When you look at the price graph on the right hand side, there’s been substantial depression in prices of assets. That’s a bad news, if you were a historical golf course owner as a prospective buyer or an investor in the asset that could create some great opportunities.

We’re looking at a handful of different assets in the market place. We are looking at one substantial portfolio and we’re also looking at a golf-related investment that I think is also interesting. So all too early to speculate as to whether or not they’ll turn into rule investment opportunities or not. But this is a new area for us and as I said we announced that we first made the investment. We’re still very much in the process of trying to determine if this is what we hope is a great trade or is it now trading to a business line for us.

I would say I’m more optimistic probably today than I was 90 days ago, about the latter being the case because it does seem like the performance that we’re getting from our assets is encouraging. And we think that the market opportunities will be encouraging as well but still it’s a modest investment for us and long ways for making a profound investment in the overall sector.

With that, let me turn it over to Justine to run through the financial results. Justine?

Justine Cheng

Thanks Wes. Turning to page 21, I’ll be reviewing the financial results in some detail. We had a very strong second quarter from both an investment and earnings perspective. On the senior housing front, we invested $199 million to acquire $214 million of senior housing assets.

And with the real estate legacy debt portfolio, we generated total return of capital of $174 million to fund those new acquisitions. As a result of these activities, we finished the quarter with $700 million of equity invested in senior housing, $373 million of expected recovery value in our legacy portfolio and $79 million of invested equity in our golf business.

Our core earnings for the quarter was $30 million or $0.09 per share. As Ken discussed, it was an excellent quarter for us to monetize our legacy to assets. We sold $345 million of loans and securities for an average price of 102.5% a par, which generated $137 million of principal recovery and $36 million of net gain. Those gains of $0.10 per share are excluded from our core earnings.

In addition, we held a large average uninvested cash balance during the quarter of $87 million, which would have generated an additional penny in earnings, had we invested at a mid teens return at the beginning of the quarter.

Breaking our core earnings down, our three segments generated $41 million of net investment income, which is before Newcastle’s corporate expenses. Senior housing represented roughly half of that with a $19 million contribution this quarter. This is up 6% from Q1, which reflects the organic growth we experienced in our managed portfolio, as well as acquisition growth.

It is important to note that 95% of our senior housing investments closed on the last day of the quarter. So expect those earnings to be fully reflected in 3Q. On June 30, we acquired six continuing care retirement centers in Texas for $190 million. We simultaneously entered into a 15-year triple net lease transaction with the leading and very established CCRC manager called Lifecare Company.

As was the case with Holiday, the lease terms were very attractive with initial unlevered cash yield of 7.6%, which grows every time with escalators of 3.75% in year two to four and 2.5% in years 5 to 15 or an average unlevered yield of 9.4% over the life of the lease. In addition, the lease has two five year renewal options.

Our legacy debt business contributed roughly a third of our net investment income with $14 million of earnings. While we still generate a low to mid-teens return on our legacy portfolio on a normal basis, our investment income was down from last quarter. As a portfolio declined approximately $400 million in face amount and the proceeds of which was reinvested into senior housing property.

Lastly, as we enter our peak season for golf, that business added $7 million to our net investment income as compared to last quarter, when the business had no contribution. Despite challenges in the sector, our assets are in great locations and realized strong same store year-to-date growth in both revenues and EBITDA, increasing 4% to 6% respectively.

We are encouraged with how our golf business is trending and expect continued growth with our revenue initiatives and expense reduction programs in place. Turning to GAAP income, which includes gains, other income, depreciation and amortization, acquisition, spin expenses and other non-cash charges, we generated $0.09 per share in the second quarter, which is up $0.08 per share from the first quarter.

This increase was mainly driven by our asset sale gains offset by $31 million, or $0.09 per share of real estate depreciation from our senior housing and golf properties. On June 13, we declared a Q2 common regular cash dividend of $0.10 per share or $35 million and since the start of the year, we’ve distributed a total of over $380 million of cash value to shareholders, including the new immediate stock.

In addition today, we announced that our Board of Directors approved a reverse stock split of three to one, which will change our number basic shares outstanding from $351 million to $117 million. Using yesterday’s closing price of $4.48 per share, performance for the reverse split, our stock price would be $13.44. We expect the reverse split to be effective August 18.

To conclude, we’re excited about the prospects across our three businesses. And I look forward to announcing our results in the third quarter.

I will now hand the call over to the operator for Q&A.

Sarah Watterson

Tony, you may turn over for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Bose George from KBW.

Chas Tyson - KBW

Hey, good morning. This is actually Chas Tyson in for Bose today. Just quick question on the $200 million of senior housing investments you made during the quarter. How much of the equity invested there was used from the $170 million of capital you raised from that pay downs? And how much of that is sitting around through incremental senior housing investments after quarter end?

Wes Edens

Well, all the capital for the investments have been generated internally. Here we’ve done financings against certain other properties. We’ve liquidated investments as Ken said. We still have some modest liquidity. We have sufficient liquidity for the assets around our contract. And if some of the larger portfolios came to pass, then we’d be in a position where we would need to go raise capital. But today we have tried hard to pay for the investments with internally generated cash flow and have been successful in doing so.

Chas Tyson - KBW

Got it. So would you anticipate kind of limited leverage you saw on the incremental senior housing transactions as well, just like we saw this quarter?

Wes Edens

Yes. We’re trying to have the company upon separation, look very much from a capital structure standpoint, similar to its cohorts. I mean, obviously, there are things you’ll need to do, more over time. We’ve used only secured financing and no leverage in certain cases. As opposed to unsecured financing to the lot of the other REITs are used, that will be something a tool, and the tool kit that we have expect to deploy as we are separated but its not really feasible to do so prior to that. But yes, we think that the capital structure that we intend to come out with and leverage and whatnot, we think will be similar to the rest of the industry and that’s what we’re targeting.

Chas Tyson - KBW

Got it. And then thinking about Newcastle -- new senior after that spins out, what’s the kind of big picture strategy they are going forward? I mean, you’ve got the debt portfolio. You’ve got the golf portfolio. What do you see as in terms of opportunities and where you’re looking to invest?

Wes Edens

Well, we have the debt portfolio that we think still has, as Ken said, a fair bit of upside and the -- of course, the debt portfolio, you could start it all tomorrow. We think by doing so we would leave a lot of money on the table and so we are trying to take a very steady and measured view of liquidations on things. We saw the average prices. We sold securities that was a premium to par, so we feel good about that.

We actually take a step back and look at the strategy for what we have done with Newcastle broadly. At the beginning of 2012, Newcastle was at $4.40 stock, since then we have spun out new residential, we spun out new media. We’re on the verge of spinning out the new senior housing and the math, the way I think of it is, which paid about $3 in ordinary dividend.

New media, at the time we spun it was at $12.30, I think was the spin value traded down from that point. That company has done terrifically, the management has done a wonderful job there. I think that the stock is now about $15.50 so and we think has got a lot of -- very bright future forward. That translates back into Newcastle equivalent shares of about a $1.12, I think if I do the arithmetic correctly. So you start with $4.40, adding $3 for dividend, $1.12 for new media, $4.50 for Newcastle, $6.27 for new resi, that’s a $14.89 in total. That means if you had dollar invested in Newcastle at the beginning of 2012 it’s worth $3.40 today.

So we are very happy with the returns of that and our strategy has been where it is today, which is to continue to look for what we believe our large addressable markets with supply/demand imbalances that our assets base where we think we can bring a lot of value to the table.

The golf opportunity may, certainly, has some of its characteristics. It is a very large market. It is highly fragmented. It is in decline. Those are the hallmarks of situations that can lead to good results and although, our efforts thus far are modest, $79 million in capital invested. I am encouraged by what we have seen and so, I think that’s got good prospects.

But I don’t feel like we’ve got a gun to our head from a timing standpoint with respect to the rest of Newcastle because we’ve got a very, very high quality portfolio and very steady earnings for the foreseeable future on the debt side and I think we have got period of time to get from here to there. It is a long answer to your short question, but hope it gives you some color as to how we view it.

Chas Tyson - KBW

Yes. Definitely. Thanks for the color. I appreciate it. And then, just one last kind of question, I didn’t hear Andrew White on the call, I just want to make sure, he still deployment on senior housing, maybe just working on the spin right now?

Wes Edens

No. He is not. Actually, Andrew, left the firm a number of months ago. So we have a very large team in the senior housing business here at Fortress. I think our investment we made was either in 1999 and 2000. Andrew is a very talented, young guy, he was working on the internal stuff, not so much on our external investments for a number of years. But he is not part of the management team right now.

Chas Tyson - KBW

Okay. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Matthew Howlett from UBS.

Matthew Howlett - UBS

Thanks, guys. Thanks for taking my question. Let’s start the senior housing FFO guidance. We are hoping that you provide something the way of FFO, adjusted FFO on that portfolio when in spun?

Wes Edens

We will give you every imaginable metric so you can think of, it’s all in registration right now. When that is spun we will have a great deal of clarity. I am -- I believe and I am hopeful that much has been our experience with the other spins that when we give transparency and clarity to the asset class that resulted in higher valuation. So from some of the cost perspective I think that, we are able to clearly layout the business (inaudible) where the share price is right now. But that’s all kind of pending when we are getting ready to spin it. So look for that once the documents are done.

Matthew Howlett - UBS

That was my second question on valuation but before I get to that, is it as easy to just assume what the leverage yield is on the invested equity and backing in some type of expenses so that can be presumed that the adjusted FFO will be somewhat close to that. So that midteens leverage yields?

Wes Edens

It’s close to that. I think that the actual number is just a little bit lower. Still a teen’s result but its probably low teens, again very attractive relative to mid-single digits for its cohorts, but if rough test to start with the (inaudible) deals of cap and there are handful adjustments so you make it or bring it down little bit, but that is a [Technical Difficulty]

Matthew Howlett - UBS

And then I just follow-up on valuation, I mean, the hope is to get some of these peer yield, peer cost of capital in order for senior housing to grow. You want all the senior cost of capital commensurate with the peer group. If you don’t really see that spin, it would be an option we just sell the portfolio, if you couldn’t grow accretively?

Wes Edens

Yes. I don’t think we are investing for a point in time and where the value is on the one day, we spin it. It is not necessarily reflective of what we think it will be long term. I think we again, we have a lot of experience in this sector. I think this portfolio, the properties that we have in 12,000 beds we think is the highest quality portfolio maybe in the entire sector.

It’s virtually all private pay. It’s virtually heavily concentrated independent living and assets that we know very well. So we think that the portfolio will be terrific. And I think from a evaluation standpoint, people will evaluate quality of portfolio, growth prospects organically for the portfolio and then the growth for the vehicle in its entirety to state the obvious, it’s much easier to grow a portfolio of $700 million in equity than it was $7 billion or $27 billion or whatever the biggest ones that are out there. So I feel like organically. Again when I said at the beginning, this mix of both managed and triple net is important because you can generate very substantial organic growth. If you’re good at your job and we think our guys are great at their jobs. And we think we can generate substantial growth from an acquisition standpoint also because we’re a large enough company to be taken seriously. We’re not so large that the (inaudible) acquisition doesn’t make a big difference to us.

So I would think that the quality of the portfolio plus the growth prospects for the vehicle and our sponsorship we hope will get us a great valuation. And again, we’ve had good success with the other vehicles that we have spun in this manner. And so I’m optimistic that this will be well received as well.

Matthew Howlett - UBS

Great. We’re looking forward to it. Thanks again.

Wes Edens

Thanks.

Operator

I would now like to turn the call over to Wes for closing remarks.

Wes Edens

That’s great. Well, thanks very much everybody for calling in. And we look forward to updating you on our exciting spin news and news in the company here in the next couple of months. Thank you.

Operator

This does conclude today’s conference call. You may now disconnect your lines.

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