My first article on TravelCenters of America (NYSEMKT:TA) and its relationship with Hospitality Properties Trust (NYSE:HPT) discussed how TA in its current form was basically created by HPT's purchase of TA and Petro, with a subsequent sale/leaseback of the real estate and spin-off of the operating company (TA) to HPT shareholders. With the exception of a few owned properties, TA leases virtually all of its properties from HPT under two large lease agreements (the TA lease and the Petro lease).
With the purchase of TA and Petro, HPT basically negotiated the lease rates with itself (to ensure a certain cash income from the portfolio and thereby justify the prices it paid). Given the relative size of HPT vs. TA and the higher multiples placed on a mid-cap lodging REIT vs. a small/micro-cap truck stop operator, it's clear that HPT had every incentive to make this deal as attractive as possible for itself, regardless of what the resulting TA entity would look like.
There is no sense in debating what could have or should have been done differently, and HPT management wasn't the only group in the world to not predict an economic bust in 2007. That being said, both TA and HPT are now locked into an unsustainable economic relationship that needs to be restructured. To anyone who debates this statement, I offer the following:
I included the gallons from the peak year (2007) to show that I'm not just adversely selecting unfavorable time periods. Annual fuel volumes only fell a total of 11% from the 2007 peak to the 2009 trough, and full year 2010 volume appear to be running within ~5% of peak 2007 levels. It's not as if revenue cycled down by 25% during the recession; TA's operations actually held on pretty well. This is a testament to the quality of the underlying locations and operations. Equally so, the fact the rent across all time period represents such a high level of EBITDAR shows how poorly structured the TA-HPT relationship is. These levels are clearly unsustainable, and I don't think you can find support for comparable levels of rent to EBITDAR in a healthy company in any sector.
All this leads us to the fact that TA and HPT clearly need to have a tough negotiation about the restructuring of the lease agreement. One reason that I believe a sale of TA to a third party is the only viable path forward is that the gross conflicts of interest that HPT has structured between itself and TA rob both sides of any credible claim that anyone is negotiating in the best interest of TA's shareholders.
Why is this so? Even though TA claims in its filings that a majority of its directors are independent, that statement is rather comical. While I have no doubt that the lawyers have spent ample time making sure that three "independent" directors qualify under the letter of the law, not a single one passes even a cursory common sense check with regard to independence.
Here are the five directors that make up the Board (the last three are "independent"; figures from the last proxy statement):
- Barry Portnoy: He is a founder of HPT and several other REITs including Commonwealth (NYSE:CWH) and Five Star Quality Care (NYSE:FVE). Clearly he is grossly conflicted from any negotiation, and is not considered independent.
- Thomas O'Brien: TA's current CEO, he was an executive (CFO) of HPT from 1996 to 2003. Since that time he been employed by REIT Management and Research (NASDAQ:RMR), the same management company that conducts all day-to-day operations at HPT and other REITs. Clearly he is also grossly conflicted, and is not considered independent. Regardless of his classification, it's also disturbing that the CEO remains part of the same organization that is so clearly conflicted on an operating level (TA and RMR currently split his compensation).
- Arthur Koumantzelis: He was on the board at HPT for over 10 years until TA was spun off and he went along as an "independent" director. His bio states that he has been a trustee of many other RMR-related funds, including Five Star Quality Care. Clearly, he has a relationship with RMR and Barry Portnoy going back decades, so excuse me for not feeling like he is truly conflict-free in making decisions that could harm RMR or Portnoy. He was paid $65,175 for his services in 2009, $48,000 in cash and $17,175 in stock. He owns a grand total of 14,561 shares, worth around $55,000.
- Barbara Gilmore: She was a partner at law firm Sullivan & Worchester while Barry Portnoy was chairman. She is also on the board at Five Star Quality Care. Clearly, she has a relationship with Portnoy and his other entities so, once again, she is not truly conflict-free in making decisions that could harm RMR or Portnoy. She was paid $59,175 for her services in 2009, $42,000 in cash and $17,175 in stock. She owns a grand total of 14,000 shares, worth around $53,000 (her husband owns 10,000 shares; no word on whether he is being considered for another independent director slot).
- Patrick Donelan: He has been on the board of another RMR/Barry Portnoy-led REIT, Commonwealth, since 1998. Again, it's hard to feel he is truly conflict-free in making decisions that could harm RMR or Portnoy. He was paid $58,675 for his services in 2009, $41,500 in cash and $17,175 in stock. He owns the same amount as Barbara Gilmore: 14,000 shares worth around $55,000.
Do you feel comfortable that any of these individuals is really disposed to take an uncomfortable hard line against Portnoy or RMR? How about their paltry financial alignment of interest with TA shareholders?
I'll end with some commentary from the NYSE corporate governance rules relating to independent directors:
No director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company). Companies must disclose these determinations.
Commentary: It is not possible to anticipate, or explicitly to provide for, all circumstances that might signal potential conflicts of interest, or that might bear on the materiality of a director’s relationship to a listed company (references to “company” would include any parent or subsidiary in a consolidated group with the company). Accordingly, it is best that boards making “independence” determinations broadly consider all relevant facts and circumstances. In particular, when assessing the materiality of a director’s relationship with the company, the board should consider the issue not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others.
I'll leave it up to the reader to determine whether the three independent board members of TA live up to the spirit of this guidance, especially in light of the tough choices that need to be made.
Disclosure: I am long TA.