We have heard from numerous constituents interested in NorthStar Asset Management (NYSE:NSAM) and the Colony NorthStar merger to discuss Lands and Buildings' views with respect to the shortcomings in the tri-party merger between Colony Capital (NYSE:CLNY), NorthStar Realty Finance (NYSE:NRF) and NorthStar Asset Management. We continue to believe that there are superior alternatives for NSAM shareholders and the tri-party merger as currently structured does not present the most compelling opportunity. However, to specifically address the question about what Land and Buildings would consider as fair compensation for NSAM shares in the tri-party merger, we offer the following:
NSAM is the crown jewel of the proposed Colony NorthStar tri-party merger, in our view. The value assigned in the exchange ratio in the merger agreement for NSAM amounts to about $2.4 billion, well below our estimate of the value we determined for NSAM in our January letter in the mid-$3 billion range and can be found here. Further, as we outlined in our presentation last week, NSAM management itself argued a 40x-plus multiple for NSAM was appropriate, which would translate into a $10 billion valuation for NSAM.
We have argued since that time that shareholder representation was desperately needed on the board of NSAM to ensure that value was being maximized for all shareholders. We do not believe that using last price and billing the transaction as a merger of equals adequately reflects the true value of NSAM.
In our view, the NSAM consideration must be improved and the exchange ratio adjusted to reflect at least $2.9 billion to represent an acceptable alternative for shareholders. While it is up to the boards of each company to determine how this additional consideration is paid for, we believe NSAM's management contract is a liability of NRF as is confirmed in the fairness opinions and thus should be reflected in a lower exchange ratio in the tri-party merger for NRF.
Only if the consideration is significantly boosted to fairly compensate NSAM shareholders, would the tri-party merger represent a viable option. However, even with a fair valuation, the transaction must still reflect a value-enhancing corporate strategy and governance structure.
To date, in our discussions with the presumptive management team at Colony NorthStar, we are concerned that it is reluctant to let go of the more complicated real estate investments of its past and embrace changes which would maximize value for all shareholders. To earn shareholder support management would have to:
Clearly state that Colony NorthStar will be an equity REIT which will concentrate on the ownership of core and core-plus traditional real estate in predetermined sectors, such as warehouse, rental residential, net lease and healthcare.
Clearly state that the company will generate outsized returns in these asset classes by making co-investments in funds which Colony sponsors, generating additional fee revenue on top of traditional real estate returns.
Clearly state that the company will avoid esoteric investments which have hurt both Colony's and NorthStar's valuations over time.
Articulate a strategy that will drive G&A/operating margins higher and leverage lower.
In addition to the consideration outlined above and a more focused corporate strategy, the tri-party merger must envision stronger corporate governance to represent an acceptable alternative. The corporate governance of Colony NorthStar is inadequate on several fronts and must be meaningfully enhanced by the following:
Reduce the proposed size of the Board, given that a 13-person board could be unwieldy and expensive.
Add highly regarded shareholder representatives, to a smaller more nimble board, who can help craft a clear, compelling strategy for fellow shareholders.
Require board members to step down from the board, if the person's investment in the Company goes below a predetermined threshold.
Maintain an annually elected board and permanently opt out of the Maryland Unsolicited Takeover Act (MUTA), which would eliminate the Company's ability to re-stagger the board without shareholder approval. We note that NSAM is currently incorporated in Delaware, so the optimal solution would be to keep NSAM domiciled in Delaware. There is no economic reason to domicile in Maryland and in fact, domiciling in Maryland represents a shareholder expense to move to a state with a shareholder-unfriendly regulatory climate.
Clearly state that Colony NorthStar will strive for best-in-class corporate governance in all facets.