Knowing When to Fold 'Em
In my years of investing and observing the markets, I have come to the conclusion that one of the hardest decisions to make in business is knowing when to throw in the towel. Some businesses, for whatever reason, simply cannot survive for much longer in the future. Examples are numerous throughout history: you could have been a horse and buggy manufacturer in the early days of the automobile, a netsuke carver in early modern Japan, or Blockbuster in the age of Netflix. Typically, management of troubled companies is often slow or unwilling to acknowledge that their best days are behind them and they often take shareholders with them as the company enters a period of long decline. In other cases, the management of the company could be a major factor responsible for the success of the business and when they decide to retire or to move on, the most prudent course of action is to sell off assets to capture maximum value for shareholders rather than risk their accomplishments and legacies being eroded.
One thing is certain, however: Whenever a company decides to liquidate, value investors become quite interested. This type of investing, known as Liquidation Investing, requires investors to investigate the company or underlying assets held for sale and then arrive at a conservative estimate of their value on a per share basis once all liabilities are satisfied. This type of investing requires considerable patience, a tolerance for illiquidity and "lumpy returns" as well as a firm understanding of the factors that led to the underlying situation. Despite the fact that there are numerous examples of obsolete and dying businesses in both the public and private sphere, there are relatively few cases in public markets where the management of the business does the right thing for shareholders and winds the company down in an orderly fashion. Though these situations are rare, they can offer a patient and attentive investor a significant chance to profit. This article is about one such situation.
A company which is about to enter into the final stages of liquidation is Winthrop Realty Trust (NYSE:FUR), representing an opportunity that could offer the right kind of patient investor attractive returns over the course of its orderly liquidation. After coming to the conclusion that the company was better off being liquidated in 2014, the management of Winthrop has taken steps to divest assets and satisfy most of the company's outstanding liabilities while paying a large collection of special dividends out to the shareholders. Now, the final act is about to commence and the equity of Winthrop will be delisted and exchanged for non-transferable units in a liquidation trust in slightly more than one month.
What Winthrop Realty Does (or more appropriately, Did)
(Quoted text courtesy of Google Finance)
Winthrop Realty Trust operated as a REIT with several lines of business, including direct property ownership, joint ventures and loans. In 2014, the company adopted a plan of liquidation and ceased making new investments or acquisitions. "The Company holds approximately 10 consolidated operating properties, over 10 equity investments, approximately four loans receivable, one secured financing receivable and one loan security."
Though the company once had a much larger portfolio of property, loans and investments, since making the decision to liquidate the company in 2014, Winthrop's management has gradually retired the liabilities of the company in an orderly fashion, with the company's bonds and preferred shares having been redeemed or retired and leaving a clean and much simplified balance sheet.
What are the Remaining Assets?
When examining the assets held by Winthrop, it becomes fairly apparent that shareholders are going to benefit significantly from reorganization or liquidation. With properties located in Illinois, Florida, Texas, New York, Oklahoma and Connecticut and across numerous asset classes, including Triple Net, Commercial, Industrial Multifamily and Office, the remaining Winthrop portfolio can best be described as being "unfocused." This property portfolio is held both outright and through a system of numerous joint ventures. Additionally, the company also owns several loans which represent a minority of the total assets held by the company. In this case, investors have the chance to profit from a "sum of the parts" valuation significantly exceeding the current market capitalization of the company's remaining assets.
Most of the company's holdings are what one would describe as "generic" assets, the price of which is fairly easily to determine based on market comparables and the income producing properties of the business. However, of the remaining assets in the portfolio, there is one which is likely to be the most interesting to investors due to the potential for significant appreciation: the company's 61.1% interest in 701 Seventh Avenue in the Times Square area of Manhattan. Given the extremely high prices paid for real estate in the area over recent years, this property could represent a significant "wild card" to the upside.
Some Simple Math: The Numbers on Winthrop Going into Final Liquidation
Investors who take a quick glance at the company's recent history will find that Winthrop has been liquidating assets for the past several quarters in order to redeem obligations and to pay several special dividends before converting to a liquidation trust, with the final special dividend on the freely trading equity being declared earlier this month. Now, as of June 26th, the company's shares will trade for a little over one month before they are redeemed by the company and exchanged for units in a liquidating trust on August 1st, 2016.
With a market capitalization currently standing at approximately $310 million, against net assets held for liquidation reported in the most recent 10-Q at approximately $439 million, investors stand to benefit significantly from a wind-up of the company. Subtracting the recent special dividend paid to investors of $1.25 (or approximately $45.8 million) from the $439 million figure, current investors are entitled to receive proceeds of approximately $393 million (less a $10 million management performance fee), or approximately $10.80 per share from the liquidation of the remainder of Winthrop's assets. For the sake of conservative investing, let's call the final net return to the shareholder $10.80 from now on.
Currently priced at $8.64 per share, investors are purchasing $10.80 worth of assets net of all liabilities that are now in the process of being expeditiously liquidated. Should the remaining assets in the portfolio be completely liquidated in one year from the date of delisting, investors are looking at an IRR of approximately 25%. Should this liquidation take two years to consummate, the IRR profile stands at 12.5%, and should it take 3 years, the IRR profile drops to 8.3%, a figure which is still attractive in my opinion (particularly if one were to think about this situation as a proxy for a short dated fixed income investment). Even if investors were to wait two years, the opportunity for an attractive return to be realized with relatively little risk is compelling, particularly given the fact that the management of the company has already engaged in significant marketing efforts for the portfolio of properties and is currently placing some under contract prior to the formation of a liquidating trust.
Why Invest Now?: Nimble Investors Benefit Due to Forced Institutional Selling
Through personal observation, I have noticed that companies engaging in liquidation often experience periods of irrational pricing, typically after paying a large distribution before the final liquidation event. Though companies that are liquidating often experience a short-term increase in share price upon announcement of this decision, the process is a long and time consuming one which causes many investors to disengage and move on to other opportunities several weeks or months after the initial announcement. This phenomena also occurs when investors have received one or several special liquidation distributions and are already sitting on an attractive gain which helps to motivate their selling, particularly as markets grow increasingly volatile.
Another and much more significant source of selling in the near term will be from entities like index funds, ETFs and hedge funds which are often prohibited from making investments into liquidation situations, or if they currently hold shares as part of a passive index of publicly traded securities, they will be no longer allowed to retain their ownership past the August 1st deadline where shares are redeemed for non-transferable units in a liquidating trust. This increasing supply of shares on the market has the potential to depress share prices in the near term, creating a significant opportunity for investors to acquire shares at a more attractive price point.
I believe that current market volatility surrounding macroeconomic factors combined with forced selling of large institutions and investors that are otherwise restricted from holding illiquid assets will make this situation particularly attractive to investors who are willing to tolerate a period of illiquidity, and I am optimistic that investors who monitor this situation on an active basis will have the chance to make an extremely attractive acquisition over the course of the next month as selling intensifies before the company delists itself.
A major area of risk is the fact that the company's asset base (real estate) is illiquid and that it could be difficult for the company to find a buyer for some or all of the portfolio at an appropriate price, despite this fact there have been significant efforts on behalf of the management team to be expeditious in their liquidation efforts. Another risk is that the portfolio of assets held by Winthrop could potentially lose significant value due to events such as a weakening commercial real estate markets in which their assets are located or rate hikes.
Another source of risk is structural, known as "Illiquidity Risk." Once the company's shares cease trading, investors will receive non-transferable units in a liquidation trust from which distributions will issue forth as the management of the company completes the sale of Winthrop's remaining real estate portfolio. Like all real estate transactions, especially those on a large scale, achieving maximum value can be a time consuming process which could take several years. During this period of time, investors will not be able to liquidate or otherwise transfer their ownership claim on the assets - investors are essentially receiving a bond with an indefinite maturity and a variable coupon that will mature in what will likely be 1 and at the most 3 years.
The "duration risk" of this situation is another source of significant risk for investors. The IRR profile for this investment could be significantly affected depending on the time frame in which the assets of the company are liquidated and the price investors end up paying before heading into liquidation. A one-year period of liquidation can represent a "home run" from an IRR perspective, while a three-year liquidation turnaround period could simply be "okay." It is also important for investors to understand and appreciate that it is possible (though not probable) that it may take a longer period of time to liquidate these assets or the sums realized from the sale of the portfolio may not be as high as estimated.
It is extremely important for individuals to assess the tax implications in any special situation, which are complicated. While those in tax advantaged accounts are sheltered from this consideration, it is important for those operating in a taxable environment to pay extremely close attention to the tax treatment of the assets received. A discussion of the tax consequence of liquidation can be found addressed by the company here, and it is important for investors with lingering doubts to consult with the proper advisors on this matter and to err on the side of caution.
Conclusions: Know When to Hold 'Em
Though shunned by larger institutional investors and index funds due to structural factors, situations of this nature have been always favored by value investors, including Ben Graham and Seth Klarman. I believe that for the right kind of investor, Winthrop Realty Trust's liquidation represents an attractive if not unconventional commitment to earn extremely attractive returns (even when accounting for an illiquidity premium) over the medium term.
Despite market volatility, real estate across almost all asset classes continues to trade at a rich multiple and interest rates remain low in the developed world, making stabilized real estate an attractive investment for institutional money. In this environment, the management of Winthrop has taken a prudent approach to maximizing value for shareholders while avoiding any attempts at "empire building," excessive risk or taking on dangerous levels of debt. I believe that this outcome is one of the best for shareholders and has helped to narrow the gap between the market estimate of the company's value and the value which can be realized through a piece-by-piece liquidation of the company's portfolio.
This last chance to purchase shares of Winthrop on the open market and thus to be entitled to liquidating trust distributions represents a significant opportunity for investors with the patience and the willingness to wait for the checks to arrive in the mail, hopefully sooner rather than later. Should the entire portfolio be liquidated within one year or less, investors have the opportunity for a true, if not unconventional, "home run" investment. Should it take two or even three years to realize a complete portfolio liquidation, investors will still have an attractive return profile to look forward to.
Though already an attractive investment currently, as time progresses towards the company's date of delisting (the first week of August), I would advise attentive investors to look increasingly closely at Winthrop's shares as here is a significant chance of more forced selling compounded by market volatility, something which could further enhance the already attractive total return profile of the investment going forward.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FUR over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.