Gramercy Capital: back in business

by PlanMaestro

10K and 10Qs are available and I am not dreaming them. We armchair generals tend to complain a lot about management. For once, let me send a tip of the hat to Gramercy’s CFO and his team for providing all this information in such short notice.

And the best part of all, no surprises. Expenses were higher than expected, consequence of all the negotiations, and cash was used to cure CDO 2005 but still:

  • Lots of unrestricted cash at the Parent level: $133M after curing CDO 2005 and it does not include an extra $16m, reported in subsequent events, from a loan to an unencumbered Parent property.
  • CDOs 2005 and 2006 passing OC tests: but CDO 2005 barely so might probably relapse. Still, things improving.
  • Buying own senior CDO bonds at a discount: GKK has started to use some of that cash (finally), having more than $50M at par all at the parent level.  The 30% discount is average, other CRE mREITs have achieved better deals, but it is a start.

“During 2011, the Company repurchased $46,525 and $1,734 par value of bonds issued by the Company’s 2006 and 2005 CDOs, respectively including $20,000 par value of Class A-1 from the 2006 CDO, $17,067 par value of Class A-2 from the 2006 CDO, and $667 par value of Class B from the 2005 CDO, generating gains on early extinguishment of debt of $14,418.”

A and B tranches are the most senior of CDOs 2006 and 2005. Any OC test failing, or principal payments from loans, and they get accelerated payments of their principal. Very safe investment with interesting returns.

With no recourse debt and only preferred equity financing, the current $2.9 per share comes with all these assets:

  • Cash and marketable securities: More than $3.3 per share in cash and CDO bonds at market value after netting preferred shares’ arrears.
  • Management fees: $0.2 per share in annual fees, not including success fees, from managing the former Realty division for KBS.
  • CDOs 2005 and 2006: both equity tranches passing tests and are paying for all SG&A, preferred dividends and some more.
  • Encumbered properties: real estate owned distressed but with potential: Makalei Land, Whiteface Lodge, Ontario Office.
  • Encumbered bank branches: dozens of encumbered bank branches inherited from Gramercy Realty and for sale.

Crazy cheap, though that is not what I wanted to write about. Instead, I will write about an activist investor, that seems to have his intentions in the right place, and the leaked possibility of selling the business.

I also wanted to balance these positive news and discuss two CDO loans, Jameson Inn and Hilton Las Vegas, that have been in news lately and not for the right reasons … we should not forget that CRE is still in distress. But once again, my synthesis skills are running short so I will just link to the Wall Street Journals articles so you can reach your own conclusions:

Indaba 13D

One of recent events is the activism of a new hedge fund, Indaba Capital accumulating 806,815 preferred shares (23% of the outstanding) and 966,200 common shares (2% of the outstanding) since May. In total, around $23 million in Gramercy securities that, for a fund started in March with just $150 million, must be one of its largest positions if not the largest.

A letter was attached to the revised Indaba 13D at the end of September. It seems like Indaba is a force for good:they start the letter with a congratulatory tone and then they express their legitimate concerns in a courteous manner. Not what you would expect from an activist in the Carl Icahn and Dan Loeb mold. A good start.

We would like to begin by commending Mr. Cozzi, his management team, and you, the members of the Board of Directors (all of the members of the Board of Directors collectively, the “Board”) for navigating the Company through a period of exceptional market dislocation and also successfully repositioning the Company for the future. In our view, management has been creative, opportunistic, and tireless in its efforts to preserve stockholder value.

We strongly agree with management’s efforts to isolate the Company’s liabilities at the subsidiary level and effectively eliminate liabilities at or recourse to the “parent” Company. We respect the caution management has demonstrated in regard to conserving and building capital (cash) over the last several years. From our discussions with management and our review of publicly available information, we believe that the Company’s “cleanup” effort after an unprecedented commercial real estate downturn is very near completion. As stockholders, we congratulate Mr. Cozzi, his team, and the rest of the Board.

Gramercy’s team deserves that respect. They are achieving a remarkable turnaround after the AFR acquisition blunder. And to have investors that recognize management efforts, despite the short term incentives of a Hedge Fund, is nice to see for a change.

However, the short term incentives are there. Indaba’s thesis is based on the catalyst of reestablishing the preferred shares dividend.

The purpose of this letter is twofold. First, we would like to reiterate the message that we have communicated to Mr. Cozzi in person: we believe the Company is now able and prepared to pay all accrued but unpaid dividends to the holders of the Preferred Stock (the “Preferred Stockholders”) and that such payment is in the best interests of the Company and its stockholders, both the holders of its Common Stock (the “Common Stockholders”) and the Preferred Stockholders.

Second, we hereby provide notice that Indaba delivered to the Secretary of the Company, on the date hereof, a written request (the “Meeting Request”) that the Company call a special meeting of the Preferred Stockholders (the “Special Meeting”) to elect the Preferred Director (as defined below) and Indaba has nominated Derek C. Schrier (and reserved the right to substitute another person in Mr. Schrier’s place) as nominee to be elected as the Preferred Director at such Special Meeting.

The interest of the preferred-holders is not necessarily aligned with the common-holders’. The first praises Gramercy’s conservatism and asks for more of it. The latter have been wondering when Gramercy will start a more aggressive CDO bond buyback program and negotiate warehouse lending facilities to restart lending. But I think both would agree with the following paragraphs:

Given the high dividend rate on the Preferred Stock (8.125%, a spread of over 5.15% over the United States thirty year treasury rate), the Company’s cash liquidity (noted above), net asset value (detailed in the attached Appendix), and lack of debt at the “parent” Company, we can only presume that the Company’s failure to pay accrued but unpaid dividends to the Preferred Stockholders is the cause of the substantial discount in its market value.

The amount and timing of dividends that Common Stockholders expect to receive are primary determinants of the market value of the Company’s Common Stock. The Board’s failure to authorize payment of accrued but unpaid dividends on the Preferred Stock diminishes the market’s perception of the Company’s ability and willingness to pay dividends on its Common Stock. Indeed, the Company acknowledges in its 2010 Form 10-K that “in accordance with the provisions of our charter, we may not pay any dividends on our common stock until all accrued dividends and the dividend for the then current quarter on the Series A preferred stock are paid in full.” Accordingly, the discount in the market value of the Preferred Stock due to its “non­paying” status impairs the market value of the Common Stock. We believe that a reasonable valuation of the Company’s Common Stock, as outlined in the Appendix attached to this letter, illustrates this fact.

The letter is worth reading in its entirety and includes a NAV assessment that, in my opinion, is quite conservative since it gives little value to the CDOs equity tranches, but at the same time it is appropriate for an investor that has prioritized investing in the preferred shares. Even with those numbers I like what I read: $4.1-$7.1 per share NAV.

What is Indaba?

An indaba is an important conference held by the izinDuna (principal men) of the Zulu and Xhosa peoples of South Africa (…) The term comes from a Zulu language word, meaning “business” or “matter” – Wikipedia

Indaba is also a hedge fund based in San Francisco that just launched in March with 150M AUM and a stated event driven strategy. Derek Schrier is its principal and chief investment officer.

Derek Schrier is a former Managing Member at also San Francisco based Farallon Capital Management.  There he headed the Credit and Liquidations operations group, one of the four groups within Farallon, alongside William Mellin and Rajiv Patel. The other Farallon groups are Arbitrage, Real Estate, and Restructuring and Value so we are talking about a value investing shop here.

He has an MBA from Stanford and worked after graduation in the mergers and acquisitions department at Goldman Sachs before jumping to Farallon.  Farallon’s founder Tom Steyer is also a Stanford MBA and Goldman alumni, and this bit from an interview  might hint on Indaba’s investing DNA:

One of the things we want is for people to understand that we are incredibly serious about relationships with companies and investors. We’re not traders. We’re not hostile. In order to get these kinds of returns, we think people have to want you to be their partner. – Tom Steyer

A review of Derek Schrier’s 13Gs and 13Ds while at Farallon reveals some other interesting stuff:

  • Sector focused: Among the 23 filings, 15 were related to health care, mostly pharma, and real estate finance, mostly REITs. I suppose this focus is consequence of the catalysts imbedded in these sectors: drug approvals and dividends.
  • Only occasional activism: In the period 2005-2007 with more than nineteen 13Gs filed, it includes only four 13Ds: RAM Energy RAM, Arch Capital Group ACGL, City Investing Liquidating Trust, and Gardensburger. Surprisingly, no pharmas or REITs among those.
  • CRE mREIT experience: in 2006 they reduced a 5% plus position in Arbor Realty Trust ABR, a CRE mREIT mentioned in the Gramercy’s write-ups, at the top of the boom. Nice timing for that exit and might explain his conviction in Gramercy.

One strange thing for a hedgie background: he had an interesting non-investing life. He managed the elections research and polling for the African National Congress’s during the 1994 elections, the Mandela election, and he is a member of the African Leadership Foundation board. He is also an advisor for the Corporate Governance Roundtable at Stanford and his wife Cecily Cameron was formerly a vice president of strategic planning and business development at Old Navy.

For sale

This is one catalyst I did not expect. This kind of surprises are welcomed.

Gramercy Capital Corp., the real estate investment trust whose stock has more than doubled in the past year, may consider a sale of the company after it completes a debt restructuring, said two people familiar with the plan. The shares surged almost 10 percent.

Gramercy, which is working with Wells Fargo & Co. (WFC) and the bank’s Eastdil Secured LLC unit, plans to contact private-equity firms if it pursues a sale, said the people, who declined to be identified because the process is private. TPG and Angelo Gordon & Co. are among the firms that have previously expressed an interest in the New York-based REIT, one of the people said.

“Private-equity firms looking for a publicly traded real estate platform would likely have an interest in Gramercy,” said Ben Thypin, director of market analysis for New York-based Real Capital Analytics Inc. “With the company’s restructuring in place, Eastdil should be able to shop it as an opportunity to create or grow such a platform.”

It makes sense. There are benefits for a CRE mREIT to be associated with a large private equity firm with interests in the CRE sector:

  1. CDOs low-cost long-term financing: Gramercy still has CDO 2007 in its reinvestment period to provide financing for CRE equity adventures.
  2. Financing for CDO bonds buybacks: a PE firm can provide or negotiate much needed firepower to take advantage of this opportunity. CDO 2007 is limited on how much they could buy, and CDOs 2005 and 2006 are outside their reinvestment periods
  3. Extension of CDOs life: a PE firm can replace REO inside CDOs 2005 and 2006 extending the life of them … with very good financing
  4. Increase of negotiation power: a large firm can provide leverage in the negotiations of defaulted  loans like Hilton Las Vegas and Jameson Inn. The threat of foreclosing would be much more credible with the financing to take control of the properties.

And recent market trends seem to confirm that PE equity firms are interested in this type of vehicle.

Apollo Global Management LLC (ARI), Colony Capital LLC and Starwood Capital Group LLC (STWD) are among private-equity firms that have backed publicly traded REITs. The companies are valuable to buyout firms because they invest in property and loans and have access to low-cost capital through the bond market, Thypin said.

“Publicly traded shares give the firm and its investors more liquidity than they have with their private partnership interests,” Thypin said.

Buyout managers such as TPG and KKR & Co. have been expanding their real estate efforts as they seek to rely less on traditional corporate takeovers for profits. Blackstone Group LP, the world’s largest private-equity company by total assets, is raising a new property fund slated to total about $10 billion.

Let me add another example, Newcastle Investments NCT that is associated with Fortress Investment Group FIG. CRE mREITS are also of interest to CRE funds that want access to fixed income financing. For example, Capital Trust CT is associated with Sam Zell and RAIT Financial RAS and Resource Capital RSO with the Cohen family.

Recent changes to Roger Cozzi’s and Tim O’Connor’s severance packages seem to confirm that this is Gramercy’s preferred path. And it fits with the efforts of SL Green to disentangle from Gramercy.

Some history, SL Green hired in 2008 Roger Cozzi and Tim O’Connor, to separate SL Green’s CEO and CFO from their overlapping responsibilities in both companies. SL Green also canceled SL Green’s external manager fees and filed in 2009 their intentions to reduce their position and actually sold approximately 850K shares at the end of 2010. Gramercy is an insignificant position for SL Green, a position that comes with potential legal headaches as a consequence of the close relationship of both companies during the boom.

It is also important to remind everyone that Gramercy ran in 2010 a similar process to evaluate financial alternatives. Why it was not fruitful? It seems very clear from the 10K disclosure:

During the second quarter of 2010, our board of directors retained a financial adviser to conduct discussions with various third parties regarding potential transactions to recapitalize our company. We received indications of interest from several of these parties regarding a variety of potential transactions that ranged from the acquisition of our entire company to acquisitions of parts of our assets or business, joint ventures with either or both of our Finance and Realty divisions, externalization of our management function and investment of capital through new issuances of our equity or debt securities. Some indications of interest contemplated change of control transactions or, at a minimum, significant changes in the composition of our management team and board of directors. All indications of interest were subject to significant additional due diligence by the parties submitting them and to the satisfaction of substantial qualifications and conditions, including but not limited to eliminating various of our contingent and other liabilities, restructuring Gramercy Realty indebtedness, repurchasing certain of our equity securities (including our Series A preferred stock), selling certain of our assets and obtaining the approval of our stockholders.

After reviewing the indications of interest received, and conducting discussions to understand the likelihood that the indicated terms could be improved, our board of directors decided to discontinue discussions regarding the indications of interest because, among other reasons, each of the proposed transactions was subject to conditions and contingencies that made consummation highly uncertain and none of the indications of interest appeared to offer a level of value to our stockholders that our board of directors deemed acceptable.

So it looks like the main roadblocks were lifted. Now that Gramercy is clear of external duties … shall we start the bidding?

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