Wednesday, May 16, 2018

WSJ, ADISA, and Woodbridge

I received an email from the trade group ADISA this morning that was mostly a reprint of its letter to the Wall Street Journal. The letter responds to the WSJ's May 7, 2018, article on the risks posed by private placements, with a particular focus on bad securities brokers.  The article used Woodbridge Group of Companies and the brokers that sold it as its examples.  The reporting is detailed, with its prime implication being that brokers that sell private placements are likely to have regulatory issues.  The ADISA letter states brokers that sell private placements are not bad.  The truth is likely somewhere in the middle.  

I wrote about Woodbridge last December, and included points that should serve as warnings to investors and brokers that are considering investing in or offering private placements.  I won't repeat them all, but in short, if an investment sounds too good - offering 8% one-year returns (Woodbridge debt investment example cited in the article) in a 1% investment environment - it is too good; or you are taking on so much risk the return should be at least double.  Think another way: why is a sponsor is willing to pay investors 8% when it should be able to borrow cheaper? Is that smart?  Maybe, but probably not. The answer is that the sponsor likely can't get a loan or other cheaper forms of capital, which is why it is offering such high interest rates.  And if the sponsor can't get cheaper financing, maybe the rate it is offering private placement investors is too low.  If a bank won't lend to a sponsor, neither should you. 

The WSJ article stated as fact that there were $710 billion in broker-sold private placements in 2017.  This is just staggering.  The private placements I see in the broker dealer world could not have totaled more than $10 billion in 2017, and that includes DST exchange products.  What are the other $700 billion in private, broker-sold investments?  Unfortunately, the biggest selling sponsor in the apparent tiny private placement world I see is one that offers products that pay investors an unsupported 8% distribution.

In today's or any day's investment environment there is no low risk way to earn 8% income from an investment.  This is true no matter what a broker says or a fancy brochure states. 

Friday, May 11, 2018

Why No Financial Statements?

How do public companies get away with not filing financial statements?  My last post on The Parking REIT noted that it made a filing earlier this year, stating among other items, that it was going to be late filing its 2017 10-K and this year's first quarter 10-Q.  The REIT's financial reporting process is now more complicated because the REIT, in another filing on May 3, 2018, disclosed that it dismissed its auditor, RSM (formerly named McGladrey) on April 29, 2018.  It ha only hired RSM in May 2017, when it dismissed RBSM, LLP.  The REIT has re-hired RBSM, LLP as its auditor.  The Parking REIT has now missed two reporting periods.  It is not alone in this financial disappearance game. 

Public REITs United Development Fund IV and First Capital Real Estate have not filed financial statements since the third quarter of 2015.  Public BDC First Capital Investment Corporation has not filed a financial statement since the third quarter of 2016.  United Development Fund IV dutifully makes its quarterly notification that it is "is working diligently to complete and file all necessary periodic reports as soon as practicable; however, there can be no assurance as to when the Registrant will be able to file such periodic reports."  If United Development Fund IV's current auditor, EisnerAmper LLP, can't produce a financial statement in nearly two years (it was retained in June 2016), it will never produce one.

The lack of accountability and penalty-free outcome for ignoring financial requirements has not gone unnoticed.  Private placements GPB Holdings II LP and GPB Automotive LP crossed the 2,000 investor limit in 2017 and were required to file as public companies starting in January of this year.  This means the two partnerships needed to file 10-Ks, 10-Qs, 8-Ks, and any other appropriate filings.  Neither GPB entity has filed anything so far in 2018.  And why should they?  There are no apparent repercussions for ignoring filing requirements. Broker dealers and investors don't seem to care, so why should the two GPB entities file anything. 

Snark aside, it is bad news when investment funds delay releasing financial data.

LVP - Least Valuable Player

I did not follow last year's merger of two non-traded REITs, MVP REIT I and and MVP REIT II, which raised a combined $165 million, but recent filings from the resulting REIT are worth a read.  Upon completion of the merger last fall, the new entity renamed itself The Parking REIT.  The merger is an example of a non-liquidity capital event, which are becoming all to familiar, but that is another post for another day.  In early April, the new REIT filed Form 12b-25, which is a notice of late filing.  The Parking REIT stated that it could not file its financial statements due to the following:

In February 2018, the Audit Committee of the Registrant's Board of Directors (the "Audit Committee") engaged independent legal counsel to conduct an internal investigation arising from the Audit Committee's receipt of allegations from an employee of MVP Realty Advisors, LLC, the Registrant's external advisor (the "Advisor"), regarding possible wrongdoing by the Registrant's Chairman and Chief Executive Officer, Michael V. Shustek, relating to (i) potentially inaccurate disclosures by MVP American Securities, the broker-dealer affiliated with the Advisor, to the Financial Industry Regulatory Authority, Inc. ("FINRA") relating to total underwriting compensation paid by the Advisor and its affiliates (other than the Registrant)  in connection with the initial public offerings of MVP REIT, Inc. and the Registrant and (ii) potential inaccuracies in personal financial statements of Mr. Shustek that were provided to one or more of the Registrant's lenders in connection with mortgage loans or guarantees where Mr. Shustek is a personal non-recourse carve-out guarantor.
The Audit Committee commenced the internal investigation and engaged independent legal counsel promptly upon becoming aware of the allegations. As a result of the pendency of the internal investigation, the Registrant is unable to finalize the Registrant's annual financial statements for the periods covered by the Annual Report.  While the investigation is ongoing, the Audit Committee has not found any irregularities in the Registrant's financial statements or accounting procedures, but no assurance can be given that such findings will not occur.

Just your normal financial chicanery.  On May 3, 2018, The Parking REIT's board's Audit Committee issued the results of its investigation.  I read the Audit Committee's findings as a confirmation of the allegations, but because of the REIT's plan to correct its past mistakes the board has been placated.  The REIT's broker dealer, MVP American Securities, amended its disclosures, and the REIT's Chairman and CEO Michael Shustek corrected the inaccuracies in his financial statements.  In addition the REIT agreed to hire a third party consultant to assess the REIT's internal controls, and the REIT will train employees on legal and regulatory obligations, and adopted the following Audit Committee recommendations:


o
Regularly evaluating the Board's composition for, among other things, independence;
o
Requiring the CFO to also report directly to the Board and to meet independently with the 
Board at regularly scheduled meeting and on at least a quarterly basis; and
o
Assess and evaluate, at least on an annual basis, potential additional corporate 
governance enhancements with the advice of outside legal counsel.
o
The Board declined to implement the Audit Committee's recommendation to bifurcate 
the roles of Chairman and Chief Executive Officer, but agreed to further evaluate this 
proposal for possible implementation in the future.

It is no shock that the board declined to limit Shustek's authority.  Board and Audit Committee member Allen Wolff resigned from the board, because his "philosophy and vision" are not aligned with the thinking of a majority of the board.  I am glad this REIT solved all its problems so fast and booted that pesky board member.  I can't think of any systemic financial or regulatory problems that a little training won't solve.

It does not take a genius to know that the wrong person resigned from this REIT and who is its LVP (Least Valuable Player).


Wednesday, May 09, 2018

Lack of Resource

Resource Realty has withdrawn its "innovative" office REIT.  The board of Resource Income Opportunity REIT voted to terminate the REIT's offering.  After a three-year offer period that included changing the REIT's structure to a perpetual life REIT, the board realized the REIT's investment premise stunk and that no broker wanted to sell it and no investor wanted to own it.  That the REIT only raised $2.1 million from investors over its extended offer period is a good indication of the market's low opinion of the REIT.  What a wasted effort.

C-III Capital Partners acquired Resource Realty's parent company, Resource America, in September 2016.  The expertise of C-III provided no sales boost to Income Opportunity, or to Resource's other investment funds.  After almost two years of C-III's tenure, Resource has had no new offerings, and its existing funds' capital inflows have been weak.  Through March, and after a two-year offer period, Resource's flagship apartment REIT, Resource Apartment REIT III, had only raised $45 million, which would include any sponsor contribution.  That is bad and looks like a "failure to launch" situation.  Resource's closed end funds' inflows are better, but not by much, and one, its interval fund, has seen redemptions since inception of 16.4% of capital received. The credit fund has raised $100 million net of redemptions in three years (bad), and the interval fund has raised $242 million net of redemtions in five years.  The interval fund, which was one of the first offered to broker dealers, is a distant third in terms of capital inflow behind the Griffin and Bluerock interval funds.

C-III needs to rethink its $200 million acquisition of Resource America. C-III either needs to create attractive products or shut down Resource's lame offerings all together, not that anyone would notice.  

Tuesday, May 08, 2018

Red Herring Soup

Yesterday's 8-K filing from Carter Validus Mission Critical REIT (CVMC) and today's DI Wire paraphrase of the filing omitted important information but added a nonsense red herring as a distraction.  Both the 8-K and article note that a major CVMC tenant, Bay Area Regional Medical Center, LLC, is filing for bankruptcy and is closing its facility on May 10, 2018, and the two state that CVMC is actively talking to the tenant and is pursuing all avenues to maximize shareholder value, including the sale of the property or its re-lease.  These are actions investors should expect from a sponsor.  Apart from Bay Area's bankruptcy and impending closure, Carter Validus's 8-K neglected to to discuss how the loss of Bay Area impacts the REIT.

According to CVMC's 2017 10-K released at the end of March, Bay Area's book value represented 20% of the REIT's year-end 2017 carried cost, and its lease revenue represented 21% of the REIT's contracted rental revenue.  Bay Area is the REIT's largest tenant by a wide margin, so its bankruptcy and immediate closure will have major financial repercussions for the REIT.  The next largest tenant, as measured by contracted rents, represented 12% of the REIT's contracted rental revenue, considerably less than Bay Area's 21%.  Because Bay Areas's departure rips a big hole in CVMC's revenue, what happens to CVMC's distribution, which was already lowered earlier this year?  How does Bay Area's bankruptcy effect not only the property's $86 million mortgage but the REIT's line of credit?  What happens to the REIT's NAV?  Dare I mention liquidity event timing?

CVMC's 8-K chose to avoid these questions and any disclosure beyond Bay Area's bankruptcy and plans to vacate its property, and opted for the irrelevant.  The 8-K touted Bay Area's market share and what other prominent medical groups it out performed.  DI Wire repeated this information and even added some news of its own, reporting on a Bay Area award and its trauma center's top certification.  None of this information is pertinent for a hospital that closes in two days.  As of Friday, Bay Area's market share will be a whopping 0%.  CVMC needs a trauma center, stat.

You can read the frivolity yourself; the entire two paragraphs of CVMC's 8-K is below:
On May 4, 2018, Bay Area Regional Medical Center, LLC ("Bay Area"), a tenant of Carter Validus Mission Critical REIT, Inc. (the "Company") through a wholly-owned subsidiary of the operating partnership of the Company, announced in a press release that it is closing its operations on May 10, 2018 and filing for bankruptcy in the near term. The Company is and has been actively communicating with Bay Area, and will seek all of its rights and remedies to enforce all obligations of the parties to the lease and any other agreements associated with the Company’s investment. The Company will seek to pursue all avenues to maximize stockholder value, which may include sale of the property or leasing of the building to a new tenant or tenants.
Based upon information provided recently by Bay Area, Bay Area Regional Medical Center’s Southeast Houston market share in the fourth quarter of 2017 was 12.61%, which ranked second to only one other single system, which was HCA’s Clear Lake Regional Hospital with a 36.59% market share.  According to Bay Area, Bay Area Regional Medical Center’s Southeast Houston market share outpaced Memorial Hermann Southeast Hospital, Houston Methodist’s St. John’s Hospital, and UT Medical Branch Hospital, all three of which are large systems in the Houston market.

Tuesday, March 27, 2018

Dr. Bob's Rant

You are supposed to sleep on letters or emails written in anger, or at least take a deep breath and walk around the block before hitting the Send button.  I am so glad Dr. Bob Froelich did neither when he announced his resignation as Board Chairman and Audit Chairman from First Capital Investment Corporation.  Dr. Bob's letter is unfiltered and rambling, speckled with spelling and grammatical errors, and the only thing clear in his final analogy, which attempts to clarify his argument while explaining First Capital's bad faith actions, is Dr. Bob's dislike of gingers.  Said another way - the letter is fantastic.

Here is the entire letter:

To: First Capital Investment Corporation:

This email is to serve as official notice of my resignation as Chairman of the Board & Audit Committee Chair for First Capital Investment Corporation. I can no longer continue to serve our shareholders as my major disagreements with management have finally reached a boiling point and I can not take any more of this. My major disagreements with management are twofold. 

First, there has been a complete and total lack of transparency between management and the board regarding what credits management was investing in and why. After our board approved the $3,000,000 investment in First Capital Retail communication to the board basically stopped. Our board had no knowledge of the other 6 investments that were made and why they were made and what was the investment thesis for those loans. The first time we learned of them was when we were informed that they are all in some form of default, weather actual or technical and our shareholders are looking at potential massive write downs of these underperforming assets. This board is still awaiting documentation (that I asked for as Board Chair) of investment memorandums and investment committee minutes including approval by who on the investment committee regarding all of these deals. In addition this board has never received any on going surveillance or updates on any those these investments after the investments were made. As a board we should not be kept in the dark by management and the advisor and because of this complete and total lack of transparency, and questionable if any investment approval process I am resigning.

My second major disagreement with management revolves around their proposed solution to this problem. It shows a complete and total lack of understanding of what it means to operate a company in the 40’ Act space. In the 40’ Act world when management and the advisors so grossly underperforms for our shareholders, as witnessed by the almost complete collapse of every investment the advisor has made, that advisor get fired and the board begins the exhaustive and comprehensive national search for a new advisor. That didn’t happen at FCIC. Instead the advisor is recommending and pushing through a plan that does nothing for our shareholders while it lines the advisors pocket as they walk away from this company. Our shareholders watched their wealth get destroyed while the advisor who allowed all of this to happen gets a big payday. That is just wrong. And to make matters even worse management wants to narrow the focus of this company to be a Healthcare BDC not the multi-sector BDC that all of our investors thought they were investing in. Why would any of our investors what to take on additional risk at this time by only investing in the healthcare sector? It limits your upside and provides a tremendous downside risk if that sector underperforms because there is nowhere else for you to go. I am taking off my board hat now and putting on my shareholder hat. I am a major shareholder in this company and I didn’t invest in a healthcare focused BDC. I don’t want a healthcare BDC!


It was these two major disagreements with management that led me to my decision to resign. While it may be confusing for some of our shareholders to completely understand what is happening perhaps this analogy might help them to understand what is going on. It would be like getting divorce from your spouse because they destroyed 80% of your retirement savings by spending it on having an affair. (Similar to the wealth destruction of the advisor here by investing in bad investments). Now your spouse instead of just walking away comes up with a new plan. Your spouse says why don’t you give me that remaining 20% that I didn’t destroy in the retirement savings you have and I will pick the new spouse for you. In other words you divorce me and I get to tell you who to marry and you pay me for it. And better yet, even though you know I don’t like anyone with red hair you inform me that I now have to marry someone with red hair. That is how silly this is! You would never agree to that, however, that is exactly what is going on here. The advisor instead of getting fired (divorced) comes up with a plan to find a new advisor (finding us a new spouse) and then wants paid for this transaction all the while our investors are underwater and have yet to receive a dividend. As the final icing on the cake the advisor tells us that they have decided to turn this into a healthcare BDC (the same as giving us that red haired spouse that we didn’t want). 

While I am stepping down as a board member, I am stepping up as a shareholder. I will be watching what you do very closely. The job of this board is to protect the shareholders and not to figure out a plan to help the advisor get paid after they destroyed the wealth of our shareholders.

Respectfully submitted,
Dr. Bob Froehlich
Board Chair, Audit Chair & Major Shareholder

A Tale of Bad Toys, Pierced Ears, Lousy Music, and A Misfired Gun

The past two weeks has seen four examples (that I know) of private equity transactions chocking companies to death or into bankruptcy.  Toys R Us, iHeart Media, Claire's, and yesterday Remington, the oldest gun company in America, all have declared bankruptcy, and one, Toys R Us is closing all its stores and liquidating. 

I am not going lament any of these bankruptcy filings.  Toys R Us can blame Amazon all it wants, but the Internet was around in 2005 when the PE firms acquired the toy store, and Walmart and Target sell plenty of toys, too.  I always thought Toys R Us' issues were more of a management problem.  Its stores were ugly and presented a poor shopping experience. Capital required for debt service rather than store upgrades probably helped make this worse.  iHeart Media focuses on radio, and my radio listening is way down, and how lousy and standardized radio has become, I don't plan on making a full scale return to radio listening.   I don't know much about Claire's as my ear piercing and bangles days are behind me.   I do know gun sellers are under pressure, but the troubles are recent, and if Remington - in an industry supported by a political party and the most powerful lobbying group in the country - had to surrender this fast, there were other issues at the company.

I suspect at the bottom of all these deals you will find that private equity principals received big bonuses after they convinced dumb bankers to lend them too much money.  Private equity principals banked their bonuses under phony pretenses using borrowed money with no recourse to them personally, leaving the acquired companies to figure out how to repay the debt.  I also suspect the former executives of the companies that sold to the private equity firms probably did alright, too. 

Consumers, employees, and investors are the big losers.  I always thought the purpose of business was to create long-term value for shareholders.  The goal to maximize shareholder value is the first lesson on the first day of business school.  Private equity deals work just the opposite - buying companies with other people's money, paying the PE principals immediate, big bonuses from the money borrowed to purchase the companies, and then letting the purchased companies struggle to pay the debt.  It is principal risk-free wealth maximization and shareholder wealth decimation.  Ugly business.

Monday, March 05, 2018

The Optomistic View

Colony NorthStar Credit Real Estate (CLNC) has traded over $20 per share for the better part of a week.  CLNC began trading in early February and is a new credit REIT comprised of assets from Colony NorthStar (CLNS) and two former non-traded REITs, NorthStar Real Estate Income Trust (NorthStar I) and NorthStar Real Estate Income II (NorthStar II). CLNC declared its first distribution this week, and the yields to NorthStar I and NorthStar II investors, based on an original $10.00 per share investment in the two REITs, are 6.6% and 6.1%, respectively.  This compares to the pre-merger yields of 7.0% that each REIT was paying.  (NorthStar I investors have a small amount of assets that were not part of the merger that may also pay a distribution at some point.)

Per-merger, Both NorthStar I and NorthStar II were paying more in distributions than they were generating in operating cash flow, a financial position that is unsustainable over the long run.  While CLNC's current stock price represents a discount-to-original-purchase-price of approximately 22% for NorthStar I investors and 28% for NorthStar II investors, the lower adjusted distribution is at a smaller discount than the stock price discount.  In my opinion, that investors are able to receive yields above 6% is positive news considering the previous distribution over payment.

Monday, February 12, 2018

Double Douchery

This blog is not morphing into a Walton-only rant, I promise, but I will comment on an email that Walton sent to investors last week.  The email announced that one of Walton's land funds is making a distribution on a partial property sale.  The fund sold just under half the acreage on one of its property's and is returning about $1 per share on an original $10 per share investment in the fund.  The property is being sold to an affiliate, which is a conflict of interest.  There is no mention of the property's original cost, so you can't put the sales proceeds into any context.  There is not enough information in the email to determine whether the sale covers the cost and fees related to the property.  Investors and their financial advisors need to press Walton to provide more information on the sale.