Thesis & Catalyst for American Realty Investors, Inc. (NYSE:ARL)
ARL is a real estate company trading on the New York Stock Exchange. It is controlled by Gene Phillips, from the old Southmark with a checkered past. ARL does not pay a dividend, but Mr. Phillips has been extracting huge management fees based on the real estate owned by ARL. It hardly makes sense to pay these management fees when Mr. Phillips and his control entities own 85% of the stock so if he chose to pay a dividend he would receive 85% of the dividends and the minority shareholders would receive the rest. Mr. Phillips has kept the share price depressed because of his unwillingness to pay a dividend. Additionally the stock is a small-cap stock so institutional investors do not follow it. What makes ARL interesting at this point is it appears that Mr. Phillips is finally winding down the operations of ARL and preparing to monetize the assets.
Over the last five years ARL has sold off almost $800 million worth of real estate. The real estate sales have lessened Mr. Phillips's management fees and it appears that he is preparing the company to take it private or sell it. In July of this year one of his related entities converted preferred stock of ARL into 2.5 million shares of ARL common at $6.06 a share (see 13D/A filed on 8/1/2014). This large common stock conversion along with the persistent asset sales indicates that a liquidity event for the common stock could be imminent. After all Mr. Phillips's largest asset is his 85% interest in ARL.
As can be seen by the below chart ARL stock has traded in a range of about $2-$12 a share in the past five years. The stock did spike to around $11 a share this past spring, but has steadily declined to roughly 5 dollars a share currently on very little volume.
Valuation
There currently are about 14 million shares of ARL outstanding, with a float of about 2 million shares. The Phillips entities own approximately 12 million of the remaining shares. ARL is a holding company whose primary asset is Transcontinental Realty Investors, Inc. (NYSE:TCI), which is publicly traded. TCI is approximately 85% owned by ARL. ARL consolidates TCI's results in its financial statements, so essentially ARL is 85% of TCI with some additional real estate assets. It is possible that TCI could be liquidated or collapsed into ARL, but this would still result in the same valuation as indicated below (Mr. Phillips did tender for TCI back in 2003 at $17.50 per share but not all the shares were tendered into the offer). Additionally TCI is substantially undervalued; it currently trades at about $10 per share, with a book value of $20 per share and a liquidation value of about $39 per share using the same analysis as I have used for ARL.
A Phillips-related entity recently converted its preferred stock into an additional 304,000 shares of TCI at a conversion price of $12.94-see 13D/a filed 7/11/2014). This conversion also supports the position that some type of a liquidity event may be coming.
ARL's assets primarily consist of $436 million of apartments, $178 million of commercial properties and $156 million of land. (Additionally there currently is about $27 million of real estate held on the balance sheet subject to sales contract). There also are some receivables and other assets on the balance sheet.
I have used ARL's most recent 10-Q, for my analysis. I have added back depreciation on the real estate to get to my estimate value of the income producing properties. This analysis should arrive at a reasonable valuation for the income producing properties, as the depreciation is an accounting entry and generally real estate sells for at least the original cost if not more. Also it is noteworthy that most of ARL's properties are in the Dallas-Fort Worth area, which is a very robust market. Additionally if you value their apartments based on recent apartment sales in their portfolio you will come up with even higher valuations. I have valued the land at cost which could be conservative considering almost all the land is in the Dallas-Fort Worth area. So there is some upside to the land.
I have also added back the deferred gain on assets, which is on the liability side of the balance sheet which will eventually flow through to the equity.
Using these assumptions, I come up with a value of $18-$24 a share for ARL in liquidation. Attached is a spreadsheet with two different scenarios. Table 1 is under the assumption that all of the preferred stock on ARL's balance sheet is converted into additional common shares at $6. Table 2 assumes that none of the preferred stock is converted. Virtually all of the convertible preferred stock of ARL is controlled by the Phillips entities.
Table 1
Table 2
Risk To Thesis
The real estate market could come under pressure which could affect the values in my models. But most of the real estate assets in ARL are apartments located in robust markets.
It's also possible that Mr. Phillips could make a low-ball squeeze-out bid for the minority shareholders of ARL or TCI but it would still have to be substantially higher then where the stocks currently trade (both companies are Nevada Companies and Nevada has appraisal rights).
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
