Front Yard Residential: Cheap Valuation Overshadowed By Liquidity Risk
Summary
- Amherst/RESI acquisition failed to close and RESI is down 40% since the news.
- RESI needs to refinance ~$315 million of debt in 2020 and a dividend cut likely required to complete a refinancing transaction.
- Implied cap rate of ~7.0% should provide some valuation protection.
Situation Update
On May 4, 2020, the unfortunate news came out that the take-private transaction by Amherst is terminated because "the unprecedented global health crisis has made the integration of the organizations too operationally complex and uncertain at this time", according to the Chairman and CEO of Amherst Holdings.
Instead of the $48 million reverse breakup fee, Amherst has agreed to:
- pay a $25 million fee to RESI
- purchase 4.4 million shares of RESI at $12.50/share, or $55 million proceeds, and
- provide a $20 million promissory notes to RESI maturing in two years
All things considered, this is a net positive as (1) RESI is receiving $100 million liquidity in the very near-term and (2) RESI has Amherst as one of its biggest institutional investors (excluding passive vehicles) - 4.4 million shares translates to about 7.5% pro forma equity ownership.
RESI also pre-released some operational data for Q1-2020 and April rent collection. The headline numbers look business-as-usual for now. We will get an update from the company from the earnings release on May 11.
Refinancing Risk
Notwithstanding the asset value, RESI is facing a tough maturity wall with ~$314.7 million of debt mature in 2020. Most urgently, the $142.3 million CS Repurchase Agreement is due on June 30, 2020. I suspect that it's an all-or-nothing situation - Home II and III also need to agree to an extension in order to get CS on board.
The management has been busy completing the take-private transaction and only now they are focusing on their balance sheet and maturity profile. I think there's enough asset value to go around to get all creditors on board, although I expect the cost of capital to come in slightly more expensive. To help make a refinance case, the company might consider reducing its distribution (RESI is paying ~$35 million distribution per year).
Source: Author based on company filings and presentations
Valuation
For the valuation, I'm taking the conventional cap rate approach. NOI projections for the next five years were provided by the management in the Proxy Statement, and I shocked the NOI by 10% as an attempt to capture the impact for COVID-19. The net debt and share count figures were adjusted for the Amherst alternative transaction. Sensitivity table is provided below. Land value is treated as semi-cash as RESI in theory can sell excess lands to pay down debt. I also capitalized SG&A expense at 10 times multiple.
To clarify on the pro forma adjustments:
- Net Debt: $100 million cash increase is made up $25 million breakup fee, $55 million equity investment and $20 million unsecured debt provided by Amherst. I assume RESI draws down the $20 million right away.
- Share count: 4.4 million shares issued to Amherst for the $55 million equity investment.
Source: Author based on company filings and press releases
Valuation is always very subjective so it's important to look at the market implied valuation. Given the current market cap, the implied cap rate is ~6.8% (assuming a 10% shock to FY2020 NOI). For reference, the $12.50 take-private price implies 5.7% cap rate.
SFR cap rate isn't widely published since this is a relatively new sub-asset class. For reference, CBRE North America Cap Rate Survey 2H2019 pegs the multifamily rental cap rate around 6.0-7.0% for suburban class C since 2H2013 (suburban class C is more comparable to RESI's SFR units from a quality and geography standpoint).
Conclusion
Overall I'm neutral on RESI. The valuation is certainly compelling given that the implied cap rate is closer to the high end of the historical range. In addition, SFR as a sub-asset class should perform relatively well given that it's more difficult to move an entire family around, which keeps the turnover rate in check. Also, the decision to purchase a house should in theory be delayed for many families given the economic reality. However, a levered balance sheet and a tough maturity wall keep me from being more positive on RESI.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RESI 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.
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