Colony Capital: The Big Pivot On Hold

Summary

• Shares of Colony Capital (CLNY) and Colony Credit Real Estate (CLNC) are down sharply this year as a result of the impact of the pandemic on their businesses.
• While both have seen values of their commercial real estate investments plunge, raising concerns about their viability, both have taken steps to ensure liquidity and financial flexibility.
• Based upon estimated losses and pre-COVID property valuations, I believe that CLNY can recover to $4.00 from its current level of around $1.90 over time.
• CLNC, in my opinion, is worth $7.44 today, above its current price of around $6.50.
• If losses can be avoided on its mezzanine and class B securitization tranches, my recovery estimates for both CLNY and CLNC have further upside.

In response to activist pressure precipitated by a deterioration in its financial performance and a steady decline in its stock price, Colony Capital announced in November 2019 a new strategy to focus on growing its Digital Realty and Investment Management business, divest over time its healthcare, hospitality and other equity and debt assets and sell substantially all of its investment management business to Colony Credit Real Estate (CLNC).

Most of that plan, however, is now on hold due to the economic downturn precipitated by the COVID-19 pandemic. Colony has experienced operating losses from a plunge in occupancy at its hospitality properties, more muted but still consequential declines in occupancy and increasing operating costs at its healthcare properties, payment defaults on its other senior loans, mezzanine loans, preferred equity interests and property leases and sharp declines in prices of its real estate debt securities.

As a result of the squeeze on its own profitability, Colony has announced that it is in payment default or non-compliance with $3.54 billion of its total $8.10 billion non-recourse debt, 90% of which is attached to its hospitality properties. The company is in active negotiations to execute forbearances and/or debt modifications and extend maturities on loans coming due.

Despite these challenges, Colony has taken steps to bolster its liquidity and financial flexibility. In March, it borrowed $600 million under its corporate credit facility. In late June, it amended its credit facility to ease financial covenants and add digital assets to the borrowing base. In exchange, the company paid down the facility by $200 million, leaving $800 million of cash at corporate and $100 million of available credit. In mid-July, Colony issued $300 million of 5.75% Exchangeable Senior Notes due 2025, the proceeds of which will be used to repay the maturing $400 million of 3.875% Convertible Senior Notes on January 15, 2021. Also in mid-July, the company paid the quarterly dividends on its four outstanding series of preferred stock.

In the midst of all of this, Colony has completed a change in its senior management. On July 1, Marc C. Ganzi, who was brought in to lead the Digital business, became Colony’s CEO, replacing Colony founder Thomas J. Barrack, Jr., who remains Executive Chairman. Jacky Wu, another Digital executive, is now Colony’s CFO. Longtime Colony veteran Mark M. Hedstrom continues as EVP and COO.

From here, Colony will stay focused on addressing the current challenges in its businesses. As the economy continues to improve, so should its financial performance. The company could get a boost from another round of aid to the hospitality sector from the Federal government. Although there are questions about potential long-term structural changes that could affect recovery values especially in sectors like hospitality, price discovery for real estate properties will improve with the economy.

With the normalization in economic activity, Colony will be able to proceed with its pivot to Digital and its plan to divest most of its real estate assets and the investment management business. Although there are considerable uncertainties that could limit ultimate recoveries, Colony’s stock is trading at $1.80, off of its all-time April low of $1.33, but well below its pre-COVID levels of around $6.00. Assuming that its healthcare and hospitality properties can return near to their pre-COVID valuations, my analysis suggests that the stock has upside to around $4.01 ($3.68 with the potential dilution from the conversion of the new Exchangeable Notes into equity). Growth in the Digital business and a recovery in the value of Colony’s 36.5% stake in CLNC (which would be driven by a rebound in CMBS and other real estate debt securities prices) could provide further upside.

Colony also has four series of preferred stock outstanding which are trading around $20, which is a meaningful discount to their liquidation values of $25.  At those prices, their yields are around 9%, which I view as attractive.

Colony Capital, Inc. (CLNY) will report 2020 second quarter earnings on August 7. Colony Credit Real Estate, Inc. (CLNC) will report its second quarter earnings on August 6.