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Power REIT (PW) today can best be described as a very simple, “coupon clipping” cash-generating machine. It owns four major assets, all in the form of landholdings that have been leased on a long-term basis:
- 112 miles of land underneath a railroad leased to Norfolk Southern (NYSE:NSC) that runs through parts of Pennsylvania, West Virginia and Ohio (the “Railroad”),
- 447 acres of land leased to an operating solar project near Bakersfield, California (“Regulus Solar”),
- 100 acres of land leased to operating solar projects near Fresno, California (“Tulare Solar”), and
- 54 acres of land leased to an operating solar project in Salisbury, Massachusetts (“Salisbury Solar”). Power REIT has no operational control or responsibility whatsoever with respect to these assets. Its business is, therefore, quite simple. It collects ground rent payments.
Importantly (as I will discuss later), the Railroad represents (by far) the lion’s share of the equity value and cash-generating capability of Power REIT, with a $915,000 annual net lease payment and no debt.
Back to Basics After an Ugly Decade for Shareholders
For most of its life, specifically the 43-year period from 1967-2010, the company was a “boring” single asset REIT whose only property was the Railroad. During this period, the company simply received the $915,000 annual rent payment from Norfolk Southern and then turned around and paid it out as a dividend to shareholders. This amounted to a reliable $.50-.55 per share annual dividend distribution. The arrangement worked well for the company and its shareholders as well as for Norfolk Southern. Beginning in 2011, however, things began to change dramatically.
First, the company embarked upon a new growth strategy with the stated intention of acquiring land underneath renewable energy projects subject to long-term ground leases.
And, second, the company pursued a multi-year, costly litigation effort against Norfolk Southern, claiming that the tenant was in default under its lease. Importantly, Norfolk Southern never defaulted on its obligation to make the $915,000 annual cash rent payment to Power REIT, and Power REIT never asserted this in litigation. Rather, Power REIT had claimed that Norfolk Southern was in default under the lease due to its failure to reimburse Power REIT for certain legal fees and for failing to allow Power REIT to inspect its books and records. Power REIT also alleged that Norfolk Southern owed over $17 million in "additional rent" as a result of, among other things, its disposition of certain ancillary Railroad property.
To fund the acquisition and litigation efforts, in 2011 Power REIT cut the annual common share dividend to $.40 per share. In 2013, the dividend was eliminated entirely. While the acquisition strategy met with some initial success and resulted in the purchase of leased land under three high-quality solar farms, the Norfolk Southern litigation cannot be described as anything other than an unmitigated disaster for Power REIT. On April 22, 2015, the court granted Norfolk Southern's motion for summary judgment and dismissed all of Power REIT's claims. And, upon appeal, on August 29, 2017, that verdict was affirmed by an appellate court, which essentially concluded that the over $17 million of "additional rent" due to Power REIT will only become payable upon termination of the Railroad lease. A summary of the litigation can be found on pages 20-21 of the company's most recent 10K filing and the complete set of court filings can be found here. The outcome was a particularly painful one for Power REIT shareholders. In addition to cutting and eventually eliminating the common stock dividend, the company issued $3.6 million of expensive 7.75% preferred stock in 2014 to continue to fund the acquisition and litigation strategies. In aggregate, Power REIT incurred $3.7 million (approximately $2.00 per share) of litigation and other costs related to the ultimately unsuccessful lawsuit. In the end, the company’s only reward was a codified $17 million operating loss carryforward for tax purposes that resulted from the ill-fated litigation (see page 15 of the company's investor presentation here).
Beginning in 2017, with the litigation costs largely in the rear view mirror, no further acquisition activities and no common dividend payments, Power REIT became a cash-generating engine. As of September 30, 2018, the company had over $1.6 million of cash on its balance sheet, with a projected balance of over $2 million by the first quarter of 2019. It is reasonable to assume that the company has chosen not to re-initiate a common stock dividend until it is first able to repay the expensive 7.75% preferred stock which has been locked out to prepayment until now. The preferred will become prepayable at par, in whole or in part, on February 28, 2019. And the company has sufficient cash balances and unencumbered assets to repay the preferred in its entirety at that time (see detail below). Re-establishment of the common stock dividend would logically follow immediately thereafter. Alternatively, the company is now “clean” (no litigation overhang) and shareholder value would likely be maximized through an outright sale or liquidation, as the ongoing general and administrative expenses (approximately $400,000 annually ($.20+ per share), or 20% of revenues) are very difficult to justify for this micro-micro-cap REIT.
Either way, the February 28, 2019, expiration of the non-call period on the 7.75% preferred stock likely represents the catalyst that long-suffering shareholders have been waiting for.
For valuation purposes, I have assumed two alternative scenarios. Both scenarios are based upon the latest twelve months (LTM) of public financial information disclosed in the company’s SEC filings through September 30, 2018. All per share figures are based upon 1,870,139 shares outstanding as of that date.
Stand-Alone Going Concern Valuation – Annual Dividend Reinstated at $.45/Share
The company reports a figure it refers to as “Core FFO Available to Common Shares” in its SEC filings. This figure is neither an accurate characterization of the company’s true earnings power (because it excludes the non-cash, but very real economically, issuance of over $200,000 per year of stock-based compensation to the Chairman/CEO and Directors) nor does it represent the company’s cash flow (because it excludes the heavy principal amortization payments that are required on the company’s solar land financings). For purposes of simply determining the company’s stand-alone ability to pay a dividend to common shareholders, I will start with the company’s reported figures and make certain pro forma adjustments, including for the likely repayment of the $3.6 million of 7.75% perpetual preferred stock.
The Tulare Solar property is currently unencumbered – i.e. it is owned “free and clear”. With NOI equal to $146,000 per annum, I have assumed a value for this asset of $2,250,000 (a 6.50% cap rate). In order to repay the $3.6 million of preferred stock, I assume that the company utilizes the approximately $2.0 million estimated first-quarter 2019 cash balance plus new financing proceeds from Tulare Solar of $1.6 million (approx. 70% loan-to-value) at a 5.25% fixed interest rate on a 25-year amortization schedule.
Starting with Core FFO Available to Common Shares over the latest twelve month period of $1,045,428, I perform the following adjustments:
(i) subtract existing debt amortization payments (cash) of $361,241,
(ii) subtract new pro forma debt service payments (interest and principal) on Tulare Solar of $116,385 and,
(iii) add back the eliminated preferred stock dividends of $280,141. This leaves me with pro forma Cash Available For Distribution (CAFD) to Common Shareholders of $847,943, or $.45 per share.
Importantly, with the company’s approximately $17 million net operating loss carryforward for tax purposes that resulted from the Norfolk Southern litigation, this dividend to shareholders would be considered a tax-deferred return of capital for approximately the next twenty years ($17 million/$847,943). Applying a conservative 5% dividend yield to the pro forma $.45 per share tax-sheltered dividend implies a share price in this scenario of $9.00 per share.
|"Core" FFO Available to Common Shareholders||$1,045,428|
|Less: Debt Principal Payments on Regulus and Salisbury Solar||($361,241)|
|Cash Available For Distribution to Common Shareholders (CAFD)||$684,187|
|Less: Additional Debt Service on New Tulare Solar Financing||($116,385)|
|Plus: Elimination of 7.75% Preferred Stock Dividends||$280,141|
|Pro Forma CAFD||$847,943|
|Common Shares Outstanding||1,870,139|
|Pro Forma CAFD/Share||$.45|
|Assumed Dividend Yield||5.00%|
|Implied Value per Share||$9.00|
Sale or Liquidation of Company at 6.00% Cap Rate
The Board of Directors of Power REIT must also consider whether now is the appropriate time to pursue an outright sale or liquidation of the company in order to maximize value for shareholders. Until recently, this scenario was complicated and impractical due to the significant uncertainty and variability of potential outcomes from the Norfolk Southern litigation. Now that the company is “clean” and generating significant cash flow from its highly desirable, long-term leased infrastructure assets, such a transaction becomes quite simple to execute. The fact of the matter is that a company of Power REIT’s tiny size and limited resources has no reason to exist as a stand-alone public company. The company lacks any ability to grow in a way that maximizes value for public shareholders due to the fact that its shares trade at such a deep discount to net asset value. In addition, the company spends approximately $400,000 per year (over $.20 per share, or 20% of revenues!) on General and Administrative expenses (more than half of which is share-based compensation to its Chairman/CEO and Directors) and these expenses would be eliminated entirely in a sale or liquidation scenario with the synergies benefiting public shareholders. Additionally, the universe of potential net-lease real estate buyers (both public and private) is large due to both the high quality and cash flowing nature of Power REIT’s assets and the bite-sized profile that such a transaction would represent for most buyers. Determining the potential sale/liquidation value for Power REIT is an extremely simple exercise because its business (four single-tenant real estate assets) is so strikingly simple.
A buyer of the company or its assets would obviously conduct an “asset by asset” buildup of Power REIT’s valuation by assigning values to each of its four assets individually. However, for simplicity of presentation, and because the conclusion is substantially similar, I will present the valuation on an aggregated basis for all of the company’s four assets combined. Starting with the latest twelve months of Net Operating Income ended September 30, 2018, equal to $1,576,970, I first add back General and Administrative Expenses of $391,888, leaving me with $1,968,858 of asset-level Net Operating Income. This is what a buyer would be purchasing. Next I pick a cap rate to apply to this Net Operating Income. Given that nearly half of the Net Operating Income of the company is generated by the Railroad lease, selecting an appropriate cap rate for this asset is critical. Since this is a single-tenant lease backed by Norfolk Southern, the trading level (yield) of Norfolk Southern bonds is a highly relevant reference point. In the third quarter of 2018, Norfolk Southern issued 100-year “century bonds” at a yield of 5.10%. The Railroad lease had an original 99-year term and has an infinite number of 99-year renewal terms at the option of Norfolk Southern. So, the 5.10% 100-year Norfolk Southern bonds are as good a comp as we're going to find. However, it is important to note that the Railroad lease payments to Power REIT are substantially more secure than Norfolk Southern’s general unsecured corporate bonds for three primary reasons. First, the Railroad is a core infrastructure asset, without which Norfolk Southern would be unable to conduct its core operations. Second, the Railroad rent payment of $915,000 is dramatically below market, having been a flat payment since the lease commenced in 1964 and contractually fixed at that level in perpetuity. So, in addition to being a core infrastructure/operating asset for Norfolk Southern, it is also an extremely valuable financial asset for them. And third, without getting into the minutia of the Power REIT/Norfolk Southern litigation, one thing that was made clear at the conclusion of the litigation is that if Norfolk Southern ever terminates the Railroad lease, it will owe well in excess of $17 million as a de facto termination penalty to Power REIT. For all of these reasons, the likelihood that Norfolk Southern will ever terminate its Railroad lease with Power REIT is extraordinarily low. Therefore, it could be argued that the required yield or cap rate that a buyer of the Railroad lease should require should be materially lower than the yield on Norfolk Southern’s long-duration bonds (i.e., lower than 5.10%). Keep this in mind as we think about selecting an appropriately conservative "blended" cap rate for Power REIT's four assets.
Next, we must consider appropriate cap rates for the three solar farm land assets. These can be expected to sell for cap rates ranging from 6.00-6.50%, depending on the asset, its location and the specific lease terms. The Tulare Solar asset happens to have a flat lease payment over its term, with no "bumps," which is why I earlier selected the higher end of this cap rate range to value that particular asset. I have personal knowledge of very comparable leased solar land sale transactions (I was a party to one of them) that validate this estimated pricing range.
Taking all of these valuation metrics and reference points into consideration, I selected a blended cap rate of 6.00% for Power REIT's four properties on a combined basis.
Applying this 6.00% cap rate to the $1,968,858 of asset-level Net Operating Income produces a gross asset value for the company of $32,814,300. Now we simply subtract net debt (i.e., net of cash) and preferred stock totaling $11,566,482 to arrive at an equity value attributable to common shareholders of $21,247,818. Divide this by 1,870,139 shares outstanding and we get $11.40 per share.
|Less: Property Taxes||($19,342)|
|Less: General and Administrative Expenses||($391,888)|
|Net Operating Income (Company-Level)||$1,576,970|
|Net Operating Income (Company-Level)||$1,576,970|
|Plus: General and Administrative Expenses||$391,888|
|Net Operating Income (Asset-Level)||$1,968,858|
|Divided by: Cap Rate||6.00%|
|Gross Asset Value (at Market)||$32,814,300|
|Regulus Solar Debt||$8,863,000|
|Salisbury Solar Debt||$695,000|
|Tulare Solar Debt||$0|
|Total Preferred at Par||$3,615,900|
|Total Net Debt Plus Preferred||$11,566,482|
|Equity Value Attributable to Common Shares||$21,247,818|
|Common Shares Outstanding||1,870,139|
Importantly, in this analysis I have been additionally conservative in, (i) utilizing the company’s actual cash balance as of September 30, 2018, of $1,607,418 (this will build to approximately $2 million after rent payments received in the first quarter of 2019) and (ii) I have assigned no explicit value to the company’s $17 million net operating loss carryforward that was codified as a result of the outcome of the Norfolk Southern litigation.
The time has finally come for Power REIT shareholders to be rewarded. Whereas investors purchasing shares over the past several years were burned badly by the disastrous outcome of the Norfolk Southern litigation, that uncertainty is now solidly in the past. At current prices in the $5.10-5.49 per share range, Power REIT today represents a wildly asymmetrical risk-reward proposition. The company is now generating a tremendous amount of cash by simply collecting rent and it is difficult to identify any significant downside (absent a material pickup in inflation and corresponding dramatic rise in fixed income yields) from here. On the other hand, we have a very near-term potential catalyst in the form of the expiration of the non-call period on the company’s 7.75% perpetual preferred stock which occurs on February 28, 2019. Presumably, the company has been preparing for this date and has its “ducks in a row” to repay the preferred and re-initiate a substantial common stock dividend.
Alternatively, the company’s Board of Directors may finally realize that it is not in the best interest of shareholders for Power REIT to remain an independent publicly traded company, with all of the general and administrative expenses and overhead that entails. While the Chairman/CEO, David Lesser, may be conflicted with respect to such a sale/liquidation scenario (he continues to receive 40,000 shares of restricted stock as compensation year after year...), the recent addition of a new director, Justinian Hobor, to the Board is encouraging. Mr. Hobor has beneficial ownership of 51,473 shares (substantially all of which were acquired in the open market) and he should be highly motivated to maximize value. Additionally, the company's top institutional shareholders, including Ladenburg Thalmann (134,811 shares), Wittenberg Investment Management (68,507 shares) and Renaissance Technologies (28,900 shares), have been adding to their positions and can be expected to push the company to act.
Regardless of which scenario plays out, shareholders entering at today’s stock prices are bound to be rewarded handsomely, with an estimated “going concern” value of approximately $9.00 per share and an estimated “sale/liquidation” value of $11.40 per share, representing upside of approximately 70% to 115% from recent trading levels.
Disclosure: I am/we are long PW. 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.