Inland Western, er... Retail Properties of America

The real estate investment trust formerly known as Inland Western REIT,  recently renamed Retail Properties of America (RPA), has filed several recent amendments to its S-11.  The March 23, 2012, amendment had some points worth noting.  RPA's filing listed an expected public offering share price of $10 to $12.  This price is based on RPA's 2.5 to 1 reverse stock split.  To an original investor, the estimated $10 to $12 listing share price is the equivalent of a $4.00 to $4.80 stock price.  Stated another way, the estimated RPA list price is 52% to 60% lower than an investor's original share price.  There is no assurance the estimated listing price will be realized or that the stock, once listed, will stay above the estimated price.

RPA is seeking to raise $320 million in new equity along with the listing, assuming a mid-point listing price of $11 per share.  The underwriters presented on the front page of the S-11 for the listing and stock offering are J.P. Morgan, Citigroup, Deutsche Bank Securities, KeyBanc Capital Markets, Scotiabank, Wells Fargo Securities and PNC Capital Markets.  Page 44 of the S-11, and this is my favorite part of the S-11, states how RPA plans to utilize the offering proceeds:

Affiliates of J.P. Morgan Securities LLC, Citigroup Global Markets Inc., Deutsche Bank Securities Inc., KeyBanc Capital Markets Inc., Wells Fargo Securities, LLC, PNC Capital Markets LLC and Scotia Capital (USA) Inc. are lenders under our senior unsecured revolving line of credit, and will receive their pro rata portion of the $170 million of the net proceeds from this offering used to repay amounts outstanding under our senior unsecured revolving line of credit. Accordingly, more than 5% of the net proceeds of this offering are intended to be used to repay amounts owed to affiliates of these underwriters.

One motivation for the stock offering is clear; over half the offering proceeds ($170 million of $320 million, or 53%) is going to repay the underwriters or their affiliates.  The underwriters are selling RPA equity to get repaid money they've loaned RPA.  The underwriters or their affiliates get repaid immediately, while the original equity investors have an 18-month deferred liquidity period that starts at an estimated 52% to 60% discount to their original investment in RPA.  There is nothing wrong, unethical or untoward with what the underwriters are doing, but it seems like a tough sale to me.

I wrote a post last week sharing my opinion on internalization fees.  RPA is one reason I believe the internalization fee has a limited future.  RPA's S-11, to its credit, neatly lays out many shares RPA received (its internalization fee) for its advisor in 2007:

2007 Internalization

On November 15, 2007, pursuant to an agreement and plan of merger approved by our shareholders on November 13, 2007, we acquired, through a series of mergers, four entities affiliated with our former sponsor, IREIC, which entities provided business management/advisory and property management services to us. Shareholders of the acquired entities received an aggregate of 37,500,000 shares of our common stock valued under the merger agreement at $10.00 per share. In December 2010, certain of the shareholders returned 9,000,000 shares of our common stock to us in connection with our settlement of a lawsuit relating to this

acquisition. As a result of the mergers, we now perform substantially all of our key operational activities internally. In connection with the mergers, we and our former business manager/advisor and our former property managers entered into a number agreements and amendments to agreements with The Inland Group, Inc. and certain of its affiliates. See “Certain Relationships and Related Transactions.”

RPA's former advisor, or its shareholders, owns 28,500,000 shares of RPA stock, not adjusted for the reverse stock split.   Based on the estimated share price of $4.00 to $4.80, this gives the internalization fee a current value of $114,000,000 to $138,800,000.  (Adjusting for the reverse split gives the same result - 28,500,000 shares divided by 2.5 equals 11,400,000 shares, which multiplied by $10.00 is $114,000,000, and multiplied by $12.00 is $136,800,000.)

A four-and-half-year period between internalization and listing is a long time, especially given what has happened to commercial real estate and the capital markets since late 2007.  Internalization fees may not be gone, but I don't think we'll see a situation anytime soon where investors lose over half their investment and management walks away with a $100 million payday.