NorthStar Asset Management Group's (NSAM) CEO Al Tylis on Q2 2016 Results - Earnings Call Transcript

| About: NorthStar Asset (NSAM)

NorthStar Asset Management Group Incorporated (NYSE:NSAM)

Q2 2016 Earnings Conference Call

August 04, 2016 10:00 AM ET

Executives

Al Tylis - CEO

David Hamamoto - Executive Chairman

Dan Gilbert - Chief Investment & Operating Officer

Debra Hess - CFO

Analysts

Ann Dai - Keefe, Bruyette & Woods

Operator

Good day, everyone, and welcome to the NorthStar Asset Management Group Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Al Tylis, CEO of NorthStar Asset Management. Please go ahead, sir.

Al Tylis

Thank you very much. Welcome to NorthStar Asset Management's second quarter 2016 earnings conference call.

Before the call begins, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that be made in this course of this call.

Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information provided in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with generally accepted accounting principles can be accessed through our filings with the SEC at www.SEC.gov.

I will now turn the call over to our Executive Chairman, David Hamamoto. David?

David Hamamoto

Thanks, Al. Welcome, everyone, to our conference call this morning. In addition to Al, I am joined today by Dan Gilbert, our CIO and COO; Debra Hess, our CFO; Ron Lieberman, our EVP and General Counsel; and Keith Feldman, our Managing Director of Capital Markets.

As you know on June 3, 2016 NSAM announced the conclusion of its strategic alternatives review, with a definitive agreement for a tri-party merger with Colony Capital and NorthStar Realty. We are very pleased with the outcome, as the merger transforms the companies into a world-class internally managed equity REIT with an embedded asset management platform. Colony NorthStar will be one of the largest independent real estate companies in the world, with almost 60 billion in AUM and established institutional and retail distribution channels.

This combination creates a global real estate leader well positioned for long-term growth with the potential to unlock significant shareholder value through increased revenue and expense synergies, and meaningful multiple expansion. To this end, we believe that the current implied stock price of Colony NorthStar is highly undervalued in the current market, and are committed to repurchasing up to $1 billion of Colony NorthStar common stock if the current valuation discount persists. Additionally, we expect to meaningfully benefit from the clarity that the announced merger provides to our investors, as well as to our partners, regarding NSAM's corporate strategic direction. This is especially relevant in our retail platform, which Dan will discuss momentarily as we expect that the enhanced clarity will dramatically benefit capital raising activity in our retail products in the second half of 2016.

With that, we look forward to updating you in the months ahead, and I'll turn the call over to Al.

Al Tylis

Thanks, David. As an update on the pending merger, we filed the Form S-4 registration statement on July 29, which can be found on the SEC's Web site under the name Colony NorthStar. We anticipate a successful close in January of 2017. In the meantime, we are making progress as the three companies continue to focus on integration efforts to ensure a seamless transition.

Turning to the second quarter 2016 results, NSAM reported second quarter CAD of $0.28 per share. As we've discussed in the past, in any particular quarter there are timing considerations with respect to capital raising and the deployment of cash, particularly in our retail business. These timing considerations resulted in lower acquisition fees during the second quarter, and over $600 million of cash available to be invested in our retail companies as of June 30. Regarding our recent acquisition of the Townsend Group, the Company continues to perform well, generating approximately $17.8 million of revenues, up 14% year-over-year, and approximately 8.7 million of EBITDA on a consolidated basis during the second quarter. Turning to our retail business, Dan Gilbert, NSAM's Chief Investment and Operating Officer, who has been instrumental in the success of this business, will focus his efforts on the retail platform for Colony NorthStar.

I will now turn the call over to Dan, who will provide an update on our retail platform and the marketplace. Dan?

Dan Gilbert

Thank you, Al. Our retail platform continues to expand and generate sustainable and durable fees. As previously reported, our year to date capital raising is approximately $278 million, driven primarily from our $1.65 billion NorthStar Income II product, which just recently announced its closing, targeted for the first week of November. As is typical, and as we have experienced during the closings of both NorthStar Income I and NorthStar Healthcare, we would expect significant sales momentum as we move toward the closing.

In addition, we have over 8 billion of affected products targeted to the retail marketplace, all of which have flexible structures and share classes, including our $2 billion NorthStar RXR New York Metro Real Estate non traded REIT, which has shown strong progress in building its selling group of broker dealers, and has made its first investment, and our $3.2 billion NorthStar Real Estate Capital Income fund and $3.2 billion NorthStar Corporate Income fund, both of which are 1940 Act closed end funds and have commenced their initial due diligence process as we look to build their selling groups throughout the second half of the year.

Overall, there has been a fairly dramatic reduction in sales of all direct investment products across the retail marketplace, including non traded REITs and BDCs. We have seen non traded REIT sales down approximately 60% year to date from the same period last year, with non traded BDC sales down even more. Overall consensus is that sales for all of 2016 could be down as much as 50% after being down approximately 35% from 2014 to 2015, although sales are projected to rebound somewhat over the next six months, and increase during 2017 and beyond. And we believe we'll be able to take full advantage of this trend.

Although NSAM did dramatically outperform the market in 2015, with sales up over 20% from 2014, we are currently tracking the overall market for 2016. There are a number of factors that have impacted the retail market this year, although many of these headwinds caused by these factors are moving behind us, and we are well positioned for continued growth moving forward.

By far, the greatest impact has resulted from the two main regulatory changes in the market. FINRA notice 15 02, relating to value disclosure on customer account statements, and the Department of Labor's rule on fiduciary duty, both of which hit the market in April. These regulatory changes caused independent broker dealers and their financial advisors to take a pause in order to assess the impact on their businesses, and determine how best to serve their customers' needs.

Specific to NSAM, the strategic review process and the uncertainty of its outcome has caused a large overhang on both our existing products and the review of new products. Although these factors are currently negatively impacting sales, we see the regulatory changes as a natural maturation in this market, where transparency, liquidity, and professional institutional investment management will become the driving factors of success. And the merger between NSAM, NorthStar Realty, and Colony will provide the clarity and enhancement to the sponsor that will not only allow our existing relationships to continue to move forward with us, but attract a wider pool of new capital.

In addition, having access to a large-scale combined balance sheet of Colony NorthStar will provide us a competitive advantage, as we are able to bridge transactions, provide access to co-investment opportunities, and support structures that require capital investment, all of which would be difficult for NSAM to provide without a substantial balance sheet, and virtually impossible for many of the smaller market participants in this space.

We will always be committed to and supportive of our relationships in the independent broker dealer space, and have proactively evolved our traditional non-traded REITs and our new closed end 1940 Act funds with structures and share classes that allow broker dealers and their financial advisors to continue to offer appropriate products to their customers, and help evolve their businesses in a post 15-02 DoL environment. In addition, we are working on new products such as DST 1031 offerings and Reg D private placement, with both types of products recently picking up market momentum, that will provide further flexibility to meet customer needs within this channel, and further solidify and expand our relationships there.

As we move through the rest of the year, we expect sales in this channel to increase, as financial advisors and their customers become more comfortable with the new regulatory rules, adjust their business models, and place their confidence, as they always have, in the NorthStar brand. As proof of this trend, we have seen sales of our new T share classes continue to gain momentum, and they are now our top-selling share class.

We have previously highlighted the compelling opportunity that also exists to offer both our current products, integrated new ones that work well, with those accounts managed by registered investment advisors, or RIAs, and held in the wirehouses. These types of accounts represent trillions of dollars of potential new assets. Estimates of around 3 trillion for RIAs and upwards of 8 trillion for wirehouses, with assets managed buy RIAs growing the most over the last few years.

Most of the sales in these channels will be for products that either have low upfront commissions or none at all, so that they can be placed in managed, or so called wrap accounts, where most fees are earned by financial advisors and broker dealers based on assets under management. These types of low or no commission structures work extremely well under both 15-02 and the DOL fiduciary role.

We will excel with these products as institutional sponsorship and track record become the main differentiating factors when selecting amongst similar products. This will only be enhanced by our merger with NRF and Colony. In addition, we feel the ability to provide the retail customer access to investment opportunities, alongside institutional investors, will be a key growth driver going forward in these channels. The ability to do so will also be solidified by the merger.

Our current products are implementing share classes well-suited for RIAs and wirehouses. We have already made progress on a number of significant relationships in these areas. We are also quickly developing additional products that will have structures that are well-suited to this channel, and we'll leverage our internal capabilities, like the potential interval fund with Townsend.

As we have stated consistently since we entered the retail business, we are in this market to be a long-term participant as an institutional sponsor, that will continue to build the best-in-class platform and product line-up to deliver the benefits of our experience, expertise, and track record in the retail marketplace. There has certainly been short-term focused sponsors who have abandoned their relationships in this market, and realized that the quality of the sponsor will become the determining factor to long-term success.

We however, are committed to this market and see it as an opportunity to expand the successful platform, and durable fee streams we have created, given our mix of current and future product, the momentum we expect from the recently announced close of NS II and the enhancements and clarity that the combination with NRF and Colony will provide. I will now turn the call over to Debra Hess, who will take us through the financial highlights for the quarter. Debra?

Debra Hess

Thanks, Dan, and good morning, everyone. As mentioned by Al, we filed a joint proxy prospectus that included pro forma financial information for the quarter ended March 31, 2016, and the year ended December 31, 2015. Given rules around generating pro forma financial information, we were not able to present the full expected synergy from the merger, nor the reinvestment of cash from NRF monetizations and any tax savings we expect. We reported the CAD of 54 million or $0.28 per share compared to, 60 million or $0.31 per share in the first quarter. Based on the new SEC guidelines, we've now included deferred tax in addition to current tax in our reported CAD. For Q2, we had a deferred tax benefit, which resulted in an additional $0.01 per share of CAD for the quarter.

Year-to-date, our operating margin was approximately 59%, taking into consideration Townsend, which runs at an approximate 50% margin. The operating margin for the second quarter was 67% or 71%, when you exclude Townsend. Our tax rate improved this quarter, primarily due to deductions from the Townsend acquisition; however we would continue to expect a midteens tax rate on a normalized basis. Total assets of NSAM's managed companies is approximately 40 billion, including assets under contract acquired or sold by our managed companies subsequent to the quarter.

This concludes our presentation for today. Operator, we like to open up the line for questions. Operator?

Question-and-Answer Session

Operator

[Operator instructions] We will first hear from Ann Dai of KBW.

Ann Dai

I wanted to maybe start with the commentary around the broker channel, and activity year to date. And so Al, I think as you discussed in the commentary, non-traded retails have come down year-to-date, and you talk about expecting it to rebound in the second half. How much do you feel like for you, that is brokers resuming activity post DOL and how much of that is the overhang from retail sales, strictly from your strategic review process and maybe having some impact on sales. Can you break that out to any extent?

Dan Gilbert

Ann, it's Dan Gilbert. I think those two factors, the regulatory changes and the overhang due to the NSAM strategic review, are both pretty dramatically impacting sales, and you could see the regulatory impact across the industry. I think when I look at our product line-up and the mix, and the different relationships we have in the independent broker-dealer community, it's very clear to me that not only the regulatory changes, but the strategic review process is impacting our sales. As I said in the commentary, as we sit here today, I am very bullish on how it looks going forward, given people are getting more comfortable in the regulatory environment, as they look to move forward. And as I said our key class share is going extremely well. And then the feedback we've gotten on the combined Company has been extremely positive, especially from our top tier relationships. They view it as taking a sponsor, who has always been institutional, and enhancing it to create a super sponsor in the space. So, I really feel like we are at a point here where we're going to see a pretty strong acceleration.

Ann Dai

Okay I don't know if you can speak to any activity quarter to date, but is that something you've been seeing in the numbers through July and the beginning of August?

Dan Gilbert

Yes, we've seen a pick up, as far as the activity and the sales, but it's still early, and we're seeing positive trends. We just announced the close of NS II, and as I have said in both our other products that we closed, the sales increase is dramatic in those products than what we have seen with other people when they announce closes, so we're seeing a very positive trend.

Ann Dai

Thank you. And just, maybe a follow up on the investment activity. You talked about that being a bit slower in second quarter, and just wondering if there's anything specific there, and whether you can speak to any pipeline of capital committed but not yet closed. Just give us a sense of what you're seeing out there, and maybe what might be coming?

Al Tylis

Yes some of the 600 million and more after the quarter has been committed, and we're just being thoughtful with our capital decisions at the managed companies, and certainly expect to deploy that capital over the next quarter or two.

Ann Dai

Thanks. I will hop back in queue.

Operator

[Operator Instructions] And will take another question from Ann Dai of KBW.

Ann Dai

Great, I can keep going all day. I don't know how much you can speak to the proxy, but within the proxy, there were some standalone management forecasts for 2017 and 2018, and you pretty clearly spelled out most of the assumptions around those, but just a couple questions around that. Are those forecasts assuming any divestitures of minority interests, and also are you assuming any growth at Townsend in those numbers?

Al Tylis

It doesn't assume any to vest to on a standalone basis, and it has some year over year growth in the Townsend business.

Ann Dai

Great, and you mentioned this potential new interval fund with Townsend. Is there any more color you can provide around what type of product that might be, and what it might be investing in?

Dan Gilbert

Yes, Ann it's Dan again. We've seen, and especially in those RIA and wire house channels, the interval funds, which customers can buy based on a CUSIP, so the really electronic entry versus the traditional sign a document and write a check, gain a lot of momentum. Townsend's expertise in investing capital and running funds would be used to invest in the capital in a variety of products, it could be investing in opportunity funds. It could be buying direct real estate, and it could be investing in real estate related securities. So really, as we have done in the past, harvesting the power of a co-sponsor and applying that to a clear market demand, and trying to expand it into channels that have a lot more capital than the channels we been able to sell in previously. So we're very excited about trying to get that launched and hopefully we will do it in the fourth quarter this year.

Ann Dai

Great. Thanks, and just one last one for me, regarding the wirehouse effort. So I'm just curious how the strategic review and then the announcement of the merger impacted those conversations that you're having with wire houses, and do you get the sense that also the fee structures you have in place on your new products would be attractive to those advisors and would work for those relationships?

Al Tylis

The strategic review has really directly impacted progress in that channel, and with the clarity now, we feel very confident that we'll have significant progress there, either at the end of this year or in the first quarter of next year, so that's something you should very much stay tuned to. As far as the fee structure, the fee structures are little different, where a lot of your fees come from the assets under management and incentive/promotes, but when we look at that relative to historic non-traded REITs, they all come out just about the same, even though is coming from different sources. And actually since more of its coming from things like asset management fees, which are more predictable and durable than acquisition disposition fees, we like that angle.

Operator

That does conclude the question-and-answer session for today. This also concludes today's conference call. Thank you all for your participation. You may now disconnect.

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